When the share price of French media technology group Thomson dropped, it decided a hybrid structure was its best funding option. Its chief treasurer tells Edward Russell-Walling why.

The new market in hybrid capital for corporates continues to win converts. One of the latest is Thomson, the French media technology group.

Because its share price has been weak, the company was particularly attracted by an equity-like structure that did not require the actual issue of shares. But the issue caused a stir.

Thomson, which was once part of the larger state-owned Thomson electronics group, is implementing a two-year growth plan while repositioning itself as a pure media and entertainment systems business. It recently sold its loss-making TV tubes division, having earlier exited from consumer electronics. Sales growth has been slowing, however, and the company recently warned it would miss this year’s sales and margin targets.

Accordingly, its share price has been depressed, which weighed in the balance when the company considered its funding options earlier this year. It has traditionally funded itself with equity, convertible bonds and the occasional private placement, supported at the short end by a French commercial paper programme.

Less risk, more flexibility

Thomson is pursuing a policy of reducing financial risk and increasing flexibility. One element of this has been the desire to do away with material adverse change clauses and rating triggers in its funding arrangements and, in June, it renegotiated a €1.75bn syndicated credit facility to reflect this.

This has not been drawn down and is used instead as a back-up to the company’s paper. So, with free cash flow adversely affected by restructuring, and a certain amount of refinancing to be done, Thomson decided to tap the capital markets at the end of the summer break.

“Convertibles have become less attractive,” observes Douglas Mackinney, Thomson chief treasurer and financing director. “That’s partly due to changes in accounting treatment. Under IFRS [accounting standards] you can no longer book convertibles at nominal interest rates – and that would distort our finances. But the main reason is that our share price is down.”

So the company set out to find a structure that had equity content without causing dilution. “Hybrid was a nice alternative,” Mr Mackinney says. “We were replicating one quasi-equity instrument with another.”

The deal that was finally put together qualified for 50% equity treatment by both Standard & Poor’s and Moody’s, and 100% equity under IFRS accounting standards. “Another attraction was that corporate spreads and long-term euro interest rates were at multi-year lows,” Mr Mackinney notes. “Yes, you must pay a premium to raise hybrid capital, but even that is lower than it used to be.”

Change of control covenant

The issue was led by Barclays Capital, Citigroup, Deutsche Bank and SG CIB. In the half a dozen or so European corporate hybrid deals in the past year, each has had its own peculiarities. What set the Thomson structure apart was its change of control covenant.

The covenant set the cat among the market’s pigeons, not least because they see Thomson as a possible candidate for a leveraged buy out. The cause for concern was that Thomson not only had the choice of calling the bonds at par or stepping up the coupon by 500 basis points (bp), but also had the option to defer coupon payments.

Like any other issuer of deeply subordinated debt, Thomson had to navigate between saleability and equity treatment. Mr Mackinney points out that there is no mandatory deferral trigger, which makes the bond more investor-friendly than some of its predecessors. “We wanted to avoid the instrument being downgraded three notches [from the Baa1/BBB+ senior rating],” he explains. “We were seeking a transaction that would be downgraded two notches and remain investment grade, which meant we couldn’t put in a mandatory trigger.”

He acknowledges that the prospect of a change of control can be scary for bondholders, who do not know what the new owner’s policy might be. “But if you give the investor a put option for early reimbursement, you lose the accounting equity treatment and some of the equity treatment from the rating agencies,” he says. “So we allowed some protection with a step-up if there was a change of control, and if that was referred to in a downgrade by one agency such that the senior rating fell below investment grade.”

But what about deferral? “A new owner could defer the coupon only if it stops paying dividends – and if it wants a return, that comes in the form of a dividend,” Mr Mackinney says.

He believes that, once understood, the covenant was well received and helped the transaction. Certainly, the u500m perpetual issue attracted bids of more than €1.3bn and, after some toing and froing, was tightly priced at 262.5bp over mid-swaps. However, those who claimed that the deal was too aggressively priced have so far been proved right. By late October, the spread had widened by more than 40bp.

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