When market jitters hit Innogy, Barclays Capital devised a bond exchange with parent company RWE. However, not only was the deal complicated but, as Geraldine Lambe explains, there was also real pressure to get it done quickly – and quietly.When the markets get spooked, perception is all. Little matter that one company’s disaster may bear only a passing resemblance to another company’s situation: investor sentiment can be a fragile and unpredictable animal.
After utility firm TXU Europe’s US parent pulled the plug because of a nose-dive in its own domestic profits, TXU Europe went into administration. The idea that foreign parent companies would not support ailing subsidiaries gained momentum, and the bonds of Innogy, a UK electricity supplier owned by German utility RWE, began to pay the price for the market’s jitters. Innogy’s bond spreads widened out from around 10-20 basis points over RWE’s to 50-70bps.
“Aside from widening spreads, RWE was already having the discussion that it would be better to manage funding at the group level. The group effectively had two credit curves and investors were telling RWE that they found the situation confusing,” says Stephen Jones, managing director at Barclays Capital’s Financing Solutions Group.
Weighing the options
BarCap came up with a plan designed to assuage investor uncertainty, and reduce structural subordination for the parent company in the process.
Three options were on the table: buy back Innogy’s outstanding bonds for cash; use some kind of novation process to change the obligor; or a bond exchange. The first strategy was the most simple; there was little risk but it required cash. And RWE, an acquisitive global company that had recently purchased American Water for around $5bn, did not want to pay Ł2bn at that time. Plan two was attractive for both RWE and investors: bondholders would give away yield but get a better credit, while RWE would reap benefits from simplifying the management of its paper. However, in this case, it made sense for RWE to ensure that its bonds were all under the same rules and terms and conditions, and it was not possible to change all the elements of Innogy’s documentation.
That left a bond exchange. “This strategy was ultimately selected because it achieved several aims: it was cash neutral for RWE, it enabled them to migrate investors to standardised documentation, there was no market risk – as there would have been in between raising the cash and buying back the bonds – and it simplified RWE’s bond structure,” says Jonathan Segal, director, debt capital markets at BarCap.
The resulting exchange offer included four Innogy sterling bonds with maturities going out to 2031 and one euro bond, representing all the outstanding bonds except a E500m issue due in 2004, which was excluded because of the short time to maturity. Holders of the sterling bonds were offered two new RWE sterling issues and bondholders with the 2008 E500m issue were offered a tap of an existing RWE note. Investors were also given the option to receive cash, in place of RWE securities, for 25% of each holding tendered.
Complex deal
It was a complex deal. Says Marco Baldini, a director on the syndicate desk: “It had a partial cash/note alternative. We had to set buy-back and new issue levels in two currencies at the same time, and instituted the option to reset levels if the markets moved in the intervening period. We had to match maturity buckets for investors as far as we could; there were a large number of investors involved across two currency markets; there was accrued interest on the euro tap but not accrued interest on the sterling tap. And there was the risk of information leakage.”
It was also structured in an investor-friendly way and economic terms were designed to be fair to both sides. “RWE shared the difference in spreads between existing RWE debt and Innogy’s outstanding paper. More than 50% of the profit would go to investors. Ultimately, only 5% of investors took up the cash option, showing their enthusiasm for the deal and for RWE paper,” says Mr Jones.
The first problem was to find the bondholders – without advertising to the market what RWE planned to do; one whiff of the deal would have brought the speculators in. The first stop was the Association of British Insurers (ABI). BarCap estimated that for the sterling issues, a decent proportion of investors were likely to be UK-based.
Speed of the essence
Says Mr Baldini: “The ABI can poll its members, but that is like waving a red flag to the market. We therefore established a committee made up of four members that had a significant interest. Essentially they represent their own firms, but they can also represent and recommend the deal to other investors. Because taking part in the committee process takes participants off-market, we also faced pressure to negotiate the final structure of the deal very quickly.”
The BarCap team, the client and analysts or fund managers from the representative firms gathered in the basement of the ABI’s building to haggle over terms. The team explained the rationale behind the exchange, how they proposed to structure it and the price.
“The bondholders offered a tentative counterproposal and we realised that we were some way from concluding the terms,” says Mr Jones. “There were certain concerns about such elements as credit issues and investor protection, as well as what would happen when we couldn’t match investors’ existing maturity profiles. In the second-round talks, there were a few sweaty palms. There was a lot of hard talking and analysis of the spread between all five bonds and the cash value in net present value terms. But everyone was utterly professional. Ultimately, the investors could see that it was a very fair offer.”
The ABI’s agreement was BarCap’s green light to go ahead, and the real race – to find the bulk of the bondholders and get the deal done without too much market impact – began. With the Chinese wall down, the sales force could be brought in. After the market had closed the evening before going public, the sales team was briefed, ready to hit the phones the following day.
David Parkinson, director, sales, says there were several major challenges for the sales team. First, there was the need to achieve a 75% bondholder acceptance rate. “But we had to find them first,” says Mr Parkinson. “We benefited from the fact that it was primarily a sterling process, and we have the biggest sterling sales force. We needed all our teams across Europe.”
Time was a big issue; sales had two weeks to complete the process. Mr Parkinson says that although it was a “reasonable” amount of time, towards the end things were starting to get tense.
The danger was that investors would do nothing about the offer until the end of the allotted time period – it was, after all, a free option to them. But if bondholders left it too late, they could run out of time to send instructions to custodians and paying agents, which can take two or three days to process.
“We had to really drive them,” says Mr Parkinson. “Instead of the usual three or four calls, we were making nine or 10 to get them on board. There was going to be a period of two to three days when it would be too late for some to get their votes in. It only needed one big holder to be away on holiday to pull the rug out from under the deal.”
One outstanding bond did not reach the 75% hurdle, hitting only a 56.2% acceptance level. This was mainly because it was an old bond, maturing in 2006, and had migrated out of pension funds into asset swapper and hedge fund portfolios. The fundamental value arguments just didn’t apply to their strategy; it did not suit them to unwind their positions, even if there was nothing wrong with the offer.
Getting the 150 or so investors comfortable with the deal was another major task. Mr Parkinson says: “We had to explain the mechanics of the structure – buying five bonds back in and issuing three – which was very unusual. We had to reassure them that there were no ulterior motives behind the deal. In a yield-hungry environment it was also difficult to overcome investor reluctance to drop yield.” Ultimately though, investors were won over by the fact that it was an extremely good offer. And, luckily, parent company RWE has a solid reputation for keeping bondholders informed. “There was a natural fund of goodwill that we could tap into,” says Mr Parkinson.
“We also reminded them that it was the bondholders who had originally come to us when the Innogy bonds had moved out, to get RWE to do something,” says Mr Segal.
And BarCap worked hard to adjust portfolio maturity for investors – even if it meant bonds from another issuer – to match their liabilities. “It was crucial to get everyone on board,” says Mr Parkinson.
Tense few days
There were a nail-biting last few days. BarCap knew what some investors had said they were going to do, but would not know until it was too late what had actually been done. On the Friday night before the Tuesday closure of the offer period, the number of acceptances that had been filed and were ready to go came to only 20%-30% acceptance levels – way below what was required. “The big question was, had we identified all the bondholders?” says Mr Jones. “But we knew we had done all we could.”
Last-minute nerves proved ill-founded, however. The transaction was exceptionally well received by the market, with RWE able to eliminate four of the five targeted bonds entirely.
“It is easy to suffer from paranoia on such a complex deal,” says Mr Baldini. “You worry that a house on the street is taking a view on the deal and is building a position. There are always moments of doubt.”
