According to Martin Fisch, head of ECM structured solutions for Deutsche Bank in EMEA, the big theme of the convertibles market now is M&A activity. You can access the market quite quickly as they can be put together in less than a week and placed into the market in a single day. It offers cheap funding, and with M&A on the rise, usage will only increase. Also M&A naturally makes a market more volatile, and that translates into better pricing for converts.
However, Julian Hall, global head of equity-linked origination at ABN Amro, notes that convertible issuance in M&A transactions is not yet nearly as buoyant as many predicted it would be. Europe has actually recorded a 91% increase this quarter in convertible issuance, but if you go through the 13 issues that have come out in the first three months, only three are M&A related, and two are monetizations. So we are not seeing the wall of M&A financing that everyone predicted.
Early in the cycle
Hall continues: That is because the EU bank market is so liquid that people will put a bank bridge in place first, and then look down the line to refinance that. We are still a bit early in the cycle to see converts come through, he says.
Its clear that increased M&A volumes are not the only driver of increased convertible issuance. Nevertheless, some issuers have found that equity-linked bonds are a particularly useful tool in handling todays uncertain, fast-moving and sometimes hostile takeover environment.
Two things in particular interest issuers with converts in the context of M&A, notes Claude Raiffel, head of equity-linked capital markets for HSBC. One is that the company may be facing an offer possibly hostile in which case the issuer often does not know what the take-up will be, so being able to parameter his funding needs using an instrument that can be done in a short timeframe, with limited running costs, is critical, he says. The other is during an acquisition when the issuer does not want to issue straight debt and does not want to dilute earnings per share with a share issue then a convert makes sense.
Finance and credit
Bayers launch of a 2.3 billion mandatory convertible on March 30 to fund its acquisition of Schering is one such example. Hall at ABN Amro says: Bayer decided to do a mandatory [convertible] because its ratings are under pressure and its equity is depressed. So this offered a good way to get financing and get equity credit recognition from the ratings authorities. The deal, set to mature in June 2009, has a coupon of 6.625% and a conversion premium of 17%.
Fisch points to a large amount of money chasing converts right now. We really saw a huge dip in supply in the last couple of years, he says. So we have a situation now where there is more demand than there is supply, and investors are quite receptive to new issues and indeed new structures.