By Nigel Adam
The decision was taken at a management board meeting of Bayer on January 9. Three days later telexes were on their way from Deutsche Bank inviting underwriting in $200 million of 10-year bonds in the name of Bayer International Finance NV, Curação. The coupon was set at 7¼% with an indicated par pricing, and each $1,000 bond would have warrants attached entitling the holder to subscribe for 13 shares of the Bayer parent company.
The chemical concern had been waiting offstage for some time. Bayer was considering early in 1978 how it would refinance a $125 million five-year rollover credit drawn down at that time and used in the acquisition of Miles Laboratories in the US.
Weitkemper recently celebrated his 25th anniversary at Bayer, having joined the legal staff of the financial secretariat in 1953. He was in at the very beginning of the company's US involvement, in 1954, when Mobay was set up as a joint venture with Monsanto. Weitkemper has a doctorate in law, and his training shows up in the precise but forceful manner in which he tackles Bayer's financing problems. At his Leverkusen headquarters he told Euromoney why, in this particular case, he chose the Eurobond market as a refinancing vehicle.
As a hedge against foreign exchange movements, Bayer has adopted the basic strategy of funding overseas investment as far as possible with foreign currency. Its Curação subsidiary was set up in 1969 and acts primarily as a holding company for the US operations. In the case of Miles, about half the purchase cost was met by the five-year Eurodollar credit and the rest mainly by private dollar placements.
Bayer makes extensive use of private placements, appearing only rarely in the public debt market. Domestically it issues Schuldscheine on a long-term basis, say 10 to 15 years, while in the Euromarket it puts out paper of around a seven-year maturity. But to place $200 million privately would have been an awesome if not impossible task. Hence the idea of a Eurobond.
Tied to short-term deposit rates, the Eurodollar credit proved cheap at first, but as these rates began to spiral in the third quarter of last year, so did Bayer's financing costs. "The Eurodollar market took quite a different turn from what we had expected a year ago," admitted Weitkemper. "At that time it was a very cheap form of finance. We were setting the interest rate on a short-term rollover basis – i.e. for one, three or six months – and during the first half of 1978 this turned out to be favourable. Then rates began to climb as US inflation worsened and the dollar weakened, so that by the autumn we were asking ourselves – where do we go from here?"
Without the warrant feature it simply would have been too big- Klaus Gaertner, Deutsche Bank
Talks started with the company's bankers in late autumn on the possible launch of a bond issue with warrants, and preliminary work began on the necessary documentation. But the dollar sector of the Eurobond market was not in the best of spirits at that time. "The market in November was not particularly receptive," recalled Weitkemper, "although yields were lower than they are now [at the end of January]. Then we considered bringing the issue in December, following Carter's measures to support the dollar, but the tone of the market was still too sluggish and investor interest not really lively enough."
Any thought of raising an amount less than $200 million was quickly dismissed. "We considered it as proof of strength that we should do the whole $200 million in one go. But in December it was just not on although we had everything ready," Weitkemper added.
For a straight dollar bond at the beginning of January, Bayer would in theory have had to pay 9½%-9¾%. But, as Deutsche Bank senior vice president Klaus Gaertner explained: "At that time a straight issue of $200 million probably would not have been placed. Without the warrant feature it simply would have been too big."
By the first week of the new year, with the holiday season safely out of the way, Bayer was feeling more confident about the market's capacity to absorb its mammoth issue. "We thought, as did our banking friends, that there was a vacuum in the market waiting to be filled and sufficient pent-up demand to make another dollar bond offering feasible. If we added flavour to the bonds by attaching warrants, we reckoned that would certainly stir up more interest in the deal.”
When news of the terms reached the market it caused some head-scratching among those bankers and investors unfamiliar with the warrant concept. Some thought the 7¼% offer yield too low and the amount too large, even allowing for the equity element. But, as Gaertner later explained, the underwriting response in the first two days of the selling period was good. "There were some banks who grasped the concept very quickly and who clearly spent a lot of time on it with clients, thereby creating genuine demand for the issue. To these banks we were able to offer protection.
On Tuesday January 16, the second day of the selling period, the dollar came under pressure on currency markets and weakened further during the remainder of the week. On January 18 the Bundesbank announced measures to drain liquidity, raising the Lombard rate and increasing minimum reserve ratios for bank liabilities, a move which upset the domestic stock markets. Bayer's share price closed the week DM2.50 below the 136 warrant exercise price, and the initial enthusiasm surrounding the issue began to wane. In pre-allotment trading the discount on the Bayer bonds widened on Friday to around 1½% midpoint, equal to the selling concession.
Between the following Monday and the close of the selling period on Thursday, January 25, however, demand for the issue revived on the back of a stronger tone in the secondary dollar bond market. "We then experienced a second wave of interest so that by Wednesday the issue was already oversubscribed," recalled Gaertner. The subscription agreement was signed in Düsseldorf on Thursday afternoon, and allotments followed a day later.
Was Deutsche Bank pleased with the response? When the book was finally closed the issue was around 50% oversubscribed, at $300 million. "As far as we are concerned an issue which only attracted, say, in this case $200 to $210 million could hardly be counted a great success. In the Eurobond market an issue of this size should be oversubscribed 50% or more to rank as a success. In such a long list of underwriters (around 170 in this case) there are always some banks who for various reasons put in for more than they can actually place," explained Gaertner.
The decision on how to allot the Bayer bonds, never an easy one for the lead manager, was further complicated by the last-minute rush at the end of the selling period. "A few banks had subscribed for amounts considerably in excess of what they really needed. When it came to the allotments we had to vary the proportions substantially. Those banks who had done their homework right away naturally fared better than those who waited until the last moment and had their allocations sharply cut back," Gaertner added.
Within two weeks of the book being closed on January 25, over $1 billion of new issues landed on the market
Banks having received their allotments, trading began on Monday, January 29. The Bayer bonds held up well at around 98¾-99¼with warrants and 84½-85 without warrants. Trading interest in London tended to centre on the latter, but, as one dealer put it: "Given three separate instruments to play with (including the warrants themselves) the possibilities for switching could be enormous. Depending on the various price levels it might be worth an investor buying the bonds with warrants, doing a split and then selling the warrants separately.”
Why did Bayer take the warrant route? "It's a great way of getting dollars at 7¼%," commented one London banker when the deal was announced. The company clearly felt the same. “It was a basic principle that if we were to put together a new loan in Curação, then it had to be done cheaply," Weitkemper emphasised. "And the cheapest way is always through an option loan, given the interest rate differential between that and a straight bond."
Bayer's strategy in launching a warrant issue rather than a convertible was simple. "We were able to appeal to a much wider audience," said Weitkemper. "Some investors are interested in the fixed interest dollar aspect of the bond, others in the warrants as a means of getting into the Bayer equity. With a convertible the bondholder, if and when he converts, becomes the shareholder. In this case the two categories may well be totally different. The bondholder can lay off some of his risk by stripping out the warrants and selling them to those who prefer to speculate in the shares."
Few investors in the Eurobond market would claim to be totally familiar with warrants, which rarely feature in international issues. Banks are obliged to spend a good deal of time and energy to convince all but the most sophisticated client that a bite at the warrant apple might be worthwhile. The Bayer warrants hold two main attractions: a relatively low premium (around 15% in early February) over their DM136 exercise price, and an early detachment date of March 1. On the other side of the coin, those investors holding warrants from Bayer's $75 million bond issue in 1969 at an exercise price of DM200 have been disappointed, as the share price has remained well below that level ever since.
Undoubtedly some of the warrants will find their way back into German hands. Deutsche Bank's Gaertner commented: "I think demand for the warrants themselves will prove stronger in Germany than abroad. On the other hand interest in the bonds ex-warrants seems to be greater outside Germany. Judging by the initial placement, if one had to guess where the paper will be in about three months' time [i.e. at the end of April] I would say a proportion of the bonds will have moved into foreign portfolios and part of the warrants into domestic German accounts."
The choice of Deutsche Bank as lead manager for the Bayer deal surprised nobody. “It's no secret that Deutsche has traditionally been our biggest banker, and we have had it in the lead group for other Euromarket deals," said Weitkemper. Deutsche Bank management board member Wilhelm Christians sits on the Bayer supervisory board, and relations between the two concerns have always been close.
Co-managers of the issue were Morgan Stanley International, Commerzbank and Credit Suisse First Boston and the four banks together initially underwrote the entire $200 million. "Four in the management group was quite enough. It's difficult if you bring too many managers into the lead group, and the line has to be drawn somewhere," commented Weitkemper.
All three co-managers had a valid claim to be included. Morgan Stanley has strong links with Bayer in its capacity as a US investment house. The acquisition of Miles Laboratories, now virtually complete, was carried out through Morgan.
Commerzbank too is historically close, and participated in the $125 million five-year rollover credit; hence the invitation to join in the refinancing.
"As for Crédit Suisse," said Weitkemper, "our relations go back 25 years, when it was the first bank to give us a currency credit in the post-war period. We needed dollars to invest in our joint venture in the US with Monsanto but such was the currency shortage here in Germany that we could not get them. So with the approval of the German authorities we arranged with Crédit Suisse a Swiss franc loan which we were allowed to service from the foreign exchange income derived from US dividends and royalties."
The remaining syndicate underwriters, numbering around 170, are listed alphabetically in the tombstone announcement, regardless of the amount actually underwritten. This is in line with Deutsche Bank's normal practice. "We very rarely use the special bracket," said Gaertner, “preferring to list the underwriters in alphabetical order. We don't have this US system of a major, sub-major, mezzanine bracket or whatever. Of course the quotas underwritten vary, but we prefer not to make the actual amounts known."
For Deutsche Bank itself the issue was, in Gaertner's words, a sell-out. He was coy about revealing how much the bank itself actually placed, but whatever the amount none went into the bank's own account. "We would very quickly have to wind up our issuing activities if we put a large part of each loan into our own portfolio. Even Deutsche Bank cannot do that," Gaertner commented.
Subsequent events in the Eurobond market proved that Bayer did indeed get its timing right. Within two weeks of the book being closed on January 25, over $1 billion of new issues landed on the market. As the familiar signs of congestion built up, Franz-Josef Weitkemper must be glad he jumped when he did.