UBS’s pioneering deal for Scottish Power ran into a last-minute hitch. The team behind it tell Geraldine Lambe how they turned it round.It is an investment banker’s basic nightmare: a ground-breaking, carefully crafted and complex transaction is about to be scuppered at the 11th hour by forces almost beyond his control. Such was the case with UBS’s $700m hybrid convertible bond deal for Scottish Power in June.

At 10.30pm the night before it was due to be launched, a call came in from the powers-that-be in Moody’s New York office to say that the rating agency was not going to play ball.

“After weeks and weeks of discussion, Moody’s came back to us to say they weren’t sure that the clauses gave Scottish Power the equity credit they wanted, and this was a major part of the rationale behind the deal,” says James Eves, managing director and head of equity linked origination at UBS. “At that late stage it was not what we wanted to hear – we’d had all the committees and the company was ready to launch; then someone says: ‘I’ve got Moody’s on the line’.”

Corporate first

The deal was this: a perpetual bond with an eight-year step-up (of 400 basis points over US Libor on top of the existing coupon of 4%), where the payments are fully deferrable; and if its EBIT to interest ratio falls below 1.75, Scottish Power would meet coupon payments with shares rather than cash. While elements of this sort of hybrid deal are relatively common for banks and insurance companies, never before had such an issue been done for a corporate, and particularly a corporate (the holding company) rated triple B+.

If Moody’s and UBS could not agree to change some of the clauses in the deal, says Mr Eves, it might have prevented the bank from getting the paper away the following day.

“One of the clauses Moody’s weren’t happy with was, in our view, material to the note’s subordination. If we had taken that out, we would have had to go back, change the terms and conditions [a 30-page document that was ready to go] and renegotiate.”

Mr Eves says that the changes agreed, primarily including the addition of a dividend stopper (which means that if the company passes on a dividend, the deferred stock settlement mechanism kicks in), did not affect Scottish Power commercially. They clearly reassured Moody’s – at 12.30am UK time, the agency finally confirmed that it would guarantee the desired equity credit – of 20%-40% – on the deal.

After snatching a few hours’ sleep between getting the go-ahead from Moody’s at 12.30am and the final call with Scottish Power at 6am, by 6.30am the team were briefing analysts, followed by a sales briefing at 6.45am and the launch at 7.30am.

The team had heaved a collective sigh of relief that a delay was prevented, because they felt that its timing was perfect, says Philip Shelley, executive director, equity capital markets at UBS. “The ADR had reached a one-year high, with the US up by 2.2%, which would help to cushion the impact of the issue. We couldn’t have picked a better time to go to market,” he says.

Investors gave it an enthusiastic reception – the offering was increased from $500m to $700m in response to demand. The books were subscribed within an hour and closed by 11am. “And we were able to price tighter than the initial coupon range to achieve a headline rate of 4%,” says Mr Eves.

Fine-tuning capital

The drivers behind its structure lay partly in the buoyancy of the convertibles market: the combination of low interest rates and volatility with the good performance of Scottish Power’s share price made a convertible far more attractive than straight debt. But it was the equity treatment that a hybrid product would get from the rating agencies that clinched its final shape – a sure sign that corporates are increasingly likely to fine-tune their capital structures using a mechanism that has previously been the preserve of financial institutions.

“Scottish Power has been on a negative outlook with the rating agencies for about a year. While the size of this transaction was not big enough to sway them one way or another, the fact that we did a hybrid with equity credit from a rating agency will be very helpful for the company going forward. You can never predict what will happen, but our credit analysts think that at the next S&P review, there is a good chance the negative outlook will be lifted,” says Mr Eves.

Education required

But the hybrid deal created tension on all sides; not only had the team to ensure that they got the equity treatment that the company wanted from the rating agency, but they were also bringing something to the convertibles market that had never been done before. It required a fair amount of education.

“The rating agencies are very knowledgeable about this sort of deal with financial institutions, but we were bringing out something on the corporate side that hadn’t been seen before. It’s perpetual, it has a step-up and a capital replacement provision, a dividend stopper and is deferrable. We had to make sure that they were very comfortable with all of those features,” says Mr Eves.

Helping the sales force to get to grips with this new package was also crucial, he says: “There are many fantastic ideas out there, but unless you can distil all its features down to a one-minute conversation as a sales person, it’s not going to work.” The sales team had precisely 45 minutes to familiarise themselves with the unfamiliar deal structure before hitting the phones.

Share price concerns

Alex Wilmot-Sitwell, managing director and head of UK investment banking, says that Scottish Power had quickly realised the power of a hybrid convertible as a financing tool, but it took a bit longer to give the issue the green light.

“We were all very conscious of market reaction and the company did not want to be seen doing anything that was not seen to fit in with their strategic vision. They were also concerned with the effect that this issue would have on their share price,” he says.

Once Scottish Power’s management were on board, the six-week construction phase was a hectic time. As well as putting together a wholly new type of corporate issue, tax efficiency was assessed and forthcoming accounting changes had to be allowed for.

“It was as detailed a transaction as you could ever come across,” says Mr Wilmot-Sitwell.

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