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“Convertibles can only benefit from the increased volatility and rising interest rates” Viswas Raghavan, JPMorgan |
“The equity-linked market is looking a lot more favourable,” says Viswas Raghavan, head of debt and equity capital markets at JPMorgan. “Convertibles can only benefit from the increased volatility and rising interest rates. The market will also benefit from asset price corrections. When share prices go down, companies start asking themselves ‘Why should I sell my shares for lower than they were a few weeks ago when I can sell them at a premium through a convertible?’”
Others agree. “It is definitely true that low interest rates and low volatility make CBs less interesting for issuers,” says Eric Lépine, global head of sales for flow and listed products at Société Générale. “The new interest rate trend and volatility gains should mean that we will see more issues in the second half of 2006. This is good news because without new issues the secondary market would continue shrinking. The pipeline should be OK in the second half of the year but it has been pretty tough so far. In recent days the market has been too shaky for new issues so there is a need to wait for markets to become more reasonable, which happens now with, for example, the Iliad issue on June 21.”
French telecom and internet company Iliad’s €287.5 million convertible, which offers a 37% premium and 2.2% interest rate was 10 times oversubscribed, showing that investor demand for convertibles remains strong.
Although there has already been a decent volume of new issuance in 2006 compared with recent years, the approximately €8 billion of new issuance in Europe so far this year pales in comparison to estimated redemptions of €16 billion to €17 billion.
The shrinking universe of outstanding convertibles has led to a huge rise in the issuance of synthetic convertibles to feed investor appetite. Synthetic convertibles are issued by banks to investors to offer them tailor-made investment opportunities on a company of their choice. The banks do not own the stock but hedge their exposure to it. According to Société Générale, between €6 billion and €8 billion of synthetic convertibles were issued in 2005. Bankers are not, however, calling a return to the record issuance levels of 2003 when volumes hit €173.4 billion. “”Equity markets are still pretty attractive,” says Raghavan. “Unlike in 2002/03 when markets were really bad and there were a lot of companies wanting to capture upside. Companies doing acquisition financing now are still tempted to do a capital increase because equity valuations are reasonable. If the market goes down further, then the equity-linked issuance trickle we are seeing today could become a deluge. This market looks ripe for an equity-linked comeback. It’s not a deluge yet, but all the signals are there. Primary issuance in the convertible market has always been a case of feast or famine. It certainly looks like the time for feasting is not too far away.”
| Peaks and troughs |
| Global convertibles issuance |
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| Source: Dealogic |
The sophistication of the equity market has, however, increased dramatically to the point where the biggest issues nowadays tend not to be just proxies for equity or cheap debt but tailored instruments designed to achieve complex corporate finance objectives. While recent notable issues have been about fine-tuning capital structures, the next wave of innovation, according to bankers, will attempt to address accounting issues arising from the mark-to-market treatment of options under IFRS, as well as regulatory and rating issues.
M&A remains the wild card. While notable M&A-inspired convertible deals of late include Swiss Re’s SFr1 billion deal in December 2005 used to fund its purchase of GE Insurance Solutions in the US and Bayer’s €2 billion mandatory deal in March 2006, to part finance its acquisition of domestic rival Schering, BNP Paribas by contrast opted for a rights issue to fund its €7.5 billion purchase of Banca Nationale del Lavoro. The French bank raised €5.5 billion in a 1:1 rights issue in March 2006.
