Convertibles show their worth in Europe
Issuance looks to have shifted from series of individual events to something that can be described as deal flow
16 Jun 2020 | Keith Mullin
Keith Mullin
Keith Mullin

THERE have been a lot of impressive elements among moves by companies in Europe and throughout the world to raise new capital or draw down contingent sources as precautionary or emergency measures to get liquidity on the balance sheet to see them through the Covid-19 crisis.

One element that has impressed has been the speed with which this has happened, although not so surprising perhaps given how critical this process has been. Another noteworthy element has been companies’ ability to tap the full range of equity, equity-linked and debt capital markets, loan and other forms of bank debt, in some cases simultaneously securing cash from private equity, institutional or, where required, distressed funds in acquisition-style infusions.

Among this frenzied corporate capital-raising and asset-recycling process, one element that has struck me has been the emergence of convertibles in Europe as – in some cases – a critical component. It struck me because in Europe, convertible bonds have always been a backwater – albeit a perfectly formed backwater – of the capital markets and a small market in terms of capital raised by them each year.

I’ve always been a huge fan of convertibles ever since, almost 30 years ago, I was responsible for convertibles coverage at the trade media shop I worked for. While converts had long been used in the UK, the US firms that had arrived in London not long before in the wake of the UK’s Big Bang brought with them options technology, leading to a new and much more quantitative way of pricing, valuing and trading converts using bond floors, implied credit spreads and implied volatility. It was an innovation that the old hands of the UK convertible market (who were perfectly happy with dividend discounting) initially found rather bewildering.

Like all markets, converts have had their up and down years, but the sweet spot for annual issuance in Europe is no more than the mid-20s billions. Bearing in mind the trillions raised in the capital markets, that’s a bit of a rounding error (a bit like Schuldschein, the German bond/loan hybrid instrument that is a similarly sized market).

Annual convertibles issuance in Europe may not surpass average levels this year, but looking through the way companies have used converts just in the past couple of months – and which companies have used them – I was reminded just how flexible this instrument can be. In Europe, outright (long-only) funds and hedge funds still dominate the investor landscape. The issuer base, meanwhile, has a sub-investment-grade bias (implied or actual) and a universe that includes repeat issuers. In the past couple of months, issuers have perfectly encapsulated sector winners and losers of the Covid-19 crisis.

For growth companies, for companies looking to minimize debt service or those with strained balance sheets, convertibles offer the benefit of coming with ultra-low coupons, while the quid pro quo of selling stock through embedded equity call options is struck at conversion premiums that can be significantly above current trading prices. To minimize downside pressure on the stock price, convertible offerings these days often come with parallel delta placings of stock to facilitate hedging by investors wanting to isolate the options volatility. Investors can also hedge away credit and interest-rate exposure through credit default swaps and bond futures.

Through the Covid-19 pandemic, the emergence of European convertibles issuance looks to have shifted from a series of individual events to something that can be described as deal flow. What’s also been striking has been the sectors that issuers have come from, which neatly fill opposite sides of this crisis.

Down sectors

Troubled airline Norwegian Air Shuttle’s recent multi-tranche financing comprised conversion of US$1.3 billion equivalent of lease obligations and bonds into perpetual convertible bonds and conversion shares (alongside an unsecured government loan guarantee and a rights issue). The emergency restructuring came not long after the company had sold a US$150 million convertible in November 2019 (along with a US$100 million debt private placement) that had been intended to fund the airline through 2020 and beyond – before Covid-19 massacred the airline industry.

Dublin-headquartered, NYSE-listed auto tech company Aptiv materially improved its leverage and liquidity profile by selling US$1 billion in mandatory convertible preferred shares (plus US$1 billion in ordinary shares) and to pay down its fully drawn US$2 billion revolving credit facility. Steelmaker ArcelorMittal, meanwhile, sold a US$1.2 billion subordinated mandatory convertible (along with equity) to raise US$2 billion to deleverage and enhance liquidity in the face of what it called a highly uncertain environment.

Travel tech company Amadeus issued a 750 million euro convertible and 750 million euros in new shares as part of a 4 billion euro “comprehensive programme to enable the company to confront even the most adverse scenarios, based on assumptions well below the latest projections for air travel by IATA”, the company said. Others include unrated French aeronautics business Safran (800 million euro seven-year convertible), and Swiss sub-investment-grade travel retailer Dufry (350 million Swiss franc convertible and a 151 million Swiss franc share issue).

Up sectors

At the same time, growth companies and covid beneficiaries have been active users. UK online supermarket group Ocado raised just over one billion pounds sterling through an equity placing, retail offer and a 350 million pounds senior unsecured convertible – the latter paying a coupon of just 0.75% for a single B rated company.

The company is using proceeds to capitalize on the channel shift surge to online shopping, which has accelerated during lockdown. The conversion premium was 35%, which looks high. But the fact that the previous convertible the company sold in December at a 45% conversion premium was already in-the-money by the beginning of May (perfectly timed for the new deal) highlighted how well the stock has performed – up 77% since the beginning of the year.

Unrated French independent renewal energy producer Neoen sold the self-proclaimed first-ever European green convertible bond to raise 170 million euros with a coupon of 2% and a premium of 40% to finance/refinance renewable energy solar PV and wind power production or storage. Like Ocado, Neoen had sold a convert in October at a 35% premium but that deal was already in-the-money by Christmas 2019.

Others in the up sectors include food delivery company HelloFresh (175 million euro convertible with a 40% premium and 0.75% coupon); takeaway food delivery company Just Eat (300 million euro convertible plus a 400 million euro equity offering); UK medical solutions company LivaNova (US$250 million cash-settled senior exchangeable note plus concurrent capped calls to repay credit facilities); online pharmacy Zur Rose Group (175 million Swiss franc five-year convertible to fund growth and investment initiatives and adjust to significantly increased demand; and Korian, the care and support services group which sold a 400 million euro seven-year convertible at a 55% conversion premium and coupon of 0.875%.

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