Europe Hungry for Corporate Bonds, Despite Meagre Portions

In 2014, European speculative-grade issuance stayed relatively steady versus 2013, reports Taron Wade, credit analyst at Standard & Poor’s (S&P) Ratings Services, with the growth in capital markets debt funding coming mainly from companies in the broad investment-grade categories of AA, A, and BBB, as per figure 1 below.

Figure 1: European Currency-Denominated Corporate Issuance 2010 to 2014

SandP European issues 2010-14

“S&P expects speculative-grade issuance to take on a more traditional flavour in capital structures in 2015, as unsecured or subordinated debt, says Wade. “Borrowers will likely prefer loans for senior secured financing, and high-yield investors will be looking for yield.”

One major force in the European bond market is the utility sector, reflecting its ongoing demand for infrastructure funding. As an example, in September 2014 Germany’s E.ON – one of the world’s largest investor-owned power and gas companies based in Dusseldorf – successfully issued a
€113m exchangeable bond
based on shares of Swiss energy company BKW, in order to monetise its holding in BKW. “The exchangeable bond is an innovative way for us to divest mid-term our remaining 6.7 % stake in BKW,” said E.ON chief financial officer (CFO), Klaus Schäfer, at the time.

Within the four-year maturity, bondholders were given the option to exchange their bonds into BKW shares held by E.ON at a predetermined price of €32.21 per share. The figure represented a premium of 22.5% on the market price of BKW stock at the time of the issue. Investors who do not exchange their bonds until maturity will be paid back the principal amount.

What attracted particular attention was that the bond had a coupon of zero percent per year and was issued at a price of 101% – meaning that E.ON achieved a negative yield. In other words, the utility will either dispose of its stake in BKW at a premium or will, in effect, be paid to issue debt. When E.ON came to market, nine other European companies had already issued equity-linked bonds with zero yield during 2014, but no lower – suggesting a floor had been reached.

A listing was obtained on the Frankfurt Stock Exchange’s Open Market segment (Freiverkehr) and the bond was offered exclusively to a limited group of institutional investors – with those in North America, Australia, Italy, South Africa and Japan excluded – via an accelerated book-building process. The E.ON bond was the first negative-yield, equity-linked instrument in Europe, the Middle East and Africa since 2005, and the first from a German issuer since at least 2000.

The 100-year Bond

The E.ON offering was accompanied by BKW’s launch of a convertible bond into its own shares of about 165m Swiss francs (CHF), with a six-year tenor. That bond had a coupon of 0.125%. The E.ON and BKW offerings were executed concurrently by UBS.

So what drove the offerings? E.ON was looking to sell its non-core 6.7% stake in BKW, while BKW wanted to avoid the Swiss requirement to pay tax on treasury share holdings after holding them for over six years. Together, they marked the first concurrent exchangeable and convertible bond offerings since the 2008 financial crisis.

Having two equity-linked bonds from two different companies for the same underlying stock at the same time might seem like an unusual strategy – even more so as the shares in BKW are highly illiquid.

Henryk Wuppermann, E.ON’s vice president of corporate finance, commented: “The impact of the offering on BKW’s share price was minimal on the day the offerings were made, which was remarkable considering the combined deal size represented nearly 600 days of trading.” In other words it would have taken at least that many days for both the E.ON and BKW shares to be sold on stock exchanges. A remarkable set of circumstances for a bond issuance, reflecting remarkable times.

Equally remarkable is the bond programme from French energy giant EDF, which really took off over a year ago. EDF attracted notice at the start of 2014 with its €9.1bn (equivalent) multi-tranche bond issue. It raised €5.1bn (equivalent) through multi-tranche senior notes; these included a 100-year sterling bond – the first ever century bond in sterling – which raised £1.35bn (€1.86bn). A further €4bn (equivalent) came through multi-tranche hybrid notes.

Asked about its financial strategy with corporate bonds, an EDF spokesman based in Paris, told
gtnews
: “Through its bond issuance programme, in particular the latest set of issuances in January 2014, the EDF group aims to enhance its financial profile and to align its balance sheet with its long lifetime industrial assets. “

EDF is implementing a sizeable investment programme to deliver growth over the long term. Net investments reached €12bn in both 2013 and 2014 and are expected to peak at €13bn this year and then fall back to €11bn by 2018. The programme includes the development of new assets with long construction periods during which EDF allocates capital to projects that do not yet generate earnings before interest, tax and depreciation (EBITDA) – these include two new evolutionary power reactors (EPRs), Flamanville 3 and Taishan, and a liquefied natural gas (LNG) terminal at the French port of Dunkirk. Around €11bn of capital had been allocated to these assets at end 2013.

Hybrid issuances enable EDF to finance the long construction phase of such investments, while enhancing its capital structure. With the January 2014 offering, EDF issued a total of around €10bn of hybrids.

The operating lives of EDF assets typically reach 30, 40 or up to 60 years. Long-dated senior bond issuances, such as the 100-year bonds, contribute to lengthening the average maturity of the group’s debt and align it with the operating life of its assets. Asked whether EDF is still pleased with its corporate bonds, the EDF spokesperson added: “The series of bond issuances completed in January 2014 was a huge success, in terms of preparation, execution, interest from investors and pricing. All the objectives set for these issuances were met. So we are indeed pleased with that operation.”

Small is also Beautiful

It is not only Europe’s mega corporations that are turning to the bond market. Presenting its annual Deals of the Year awards, the London-based Association of Corporate Treasurers (ACT) noted that the most popular awards category for 2014 was that of bonds under £500m.

DotY chair of judges, Lesley Flowerdew, group tax and treasury director at engineering and project management consultancy Atkins, commented: “In the past, it has been the bonds over £500m category that have tended to attract most interest. So this change in direction reflects a trend in smaller companies tapping the capital markets through bond issues, often for the first time.”

However the market will expect companies with a greater risk profile to pay a commensurate price. S&P’s Wade said: “Quantitative easing [QE] has heartened the European capital markets and injected new life into the speculative-grade bond market even for B rated issuers, and, surprisingly, for smaller transaction sizes – €200m or less – despite concerns at the end of last year about liquidity for such deals. These companies are paying a higher price to access the capital markets, however.”

She adds that 2015 promises to be lively for the market. “January started off with a bang for the financial markets in Europe. Market participants have had a lot of news to digest, including the European Central Bank’s [ECB] QE programme, Greece’s political changes, and the impact of the oil price slide. But the issuance markets haven’t been fazed.”

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