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Western EuropeOctober 1 2006

JPMorgan reaps rewards of its success in Germany

JPMorgan recently followed up an IPO deal for German retailer Metro’s divestment of its DIY business, Praktiker, with an advisory role in the latter’s acquisition of a privately owned competitor. The team tell Edward Russell-Walling about their successive mandates.
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Investment banks like to boast of the seamless service, the multi-skilled capacity they offer their clients. Sadly, given the competitive landscape they inhabit, they do not always get the opportunity to flaunt it. JPMorgan recently showed how it can be done, however, with a satisfying succession of mandates from Metro and its former subsidiary, Praktiker.

Metro is the largest retailer in Germany and in central and eastern Europe. Its main focus is food, and its two principal divisions are Metro/ Makro cash and carry, which operates in more than 30 countries, and Real hypermarkets, with a predominantly German presence. It has successful European consumer electricals chains, Media Markt and Saturn, and a department store business, Kaufhof.

Until recently, that portfolio included Praktiker, a non-core do-it-yourself (DIY) chain that accounted for less than 10% of revenues and profits. The parent needed to fund further expansion in eastern Europe and Praktiker seemed an obvious candidate for divestment.

“We really began our relationship with Metro around the time of the acquisition of Makro in 1997,” says Toby Radford, JPMorgan’s head of retail investment banking in Europe. “We have remained close ever since.”

Praktiker had a chequered history. It performed poorly in the 1990s, with declining sales followed by pressure on margins. However, a new management team installed in 2000 had turned the business around, building it back up to become price leader in the German DIY market. Rumours about its sale had been circulating for some years but it was only in May 2005 that Metro announced a strategic review.

Dual-track process

“The IPO [initial public offering] market was reviving and there was a very active sponsor market,” says Klaus Hessberger, JPMorgan head of equity capital markets for Germany, Austria and Switzerland. So, initially, the bankers sounded out the possibilities of both. Praktiker had a few years’ decent earnings under its belt, and the dual-track sale process canvassed likely private equity and trade buyers as well as institutional investors in public equity.

The DIY market in Germany has more retail capacity than in any other country in Europe, and the resulting pressures on price make it one of the least profitable. Private equity proved circumspect and, early in November, the team advised Metro that its best value option was an IPO with Praktiker’s property assets stripped out for a separate sale.

“You can create value by looking at different disposal options,” says JPMorgan M&A executive Matthias Reschke. “By selling the real estate separately from the operating business, we calculated that we could achieve a significantly higher exit valuation.”

Changing circumstances

By that time, the European IPO market was less attractive than it had been earlier in the year. A new German government had promised to increase VAT charges, and bad trading news from other European DIY chains made the sector less appealing. Some said that the transparency of the dual-track process had dented the likely IPO proceeds, although the JPMorgan team disputes this. “The market is very intuitive and knows what’s going on, whether you make a public statement or not,” says Mr Reschke.

Calling off the IPO would have sent the wrong message about Metro’s – and the bankers’ – belief in the business, so it was decided to press on. The price range was lowered from €16-€19 to €14-€15 and the shares on offer were scaled back from 70% to just under 60% (including a greenshoe). The belief was that the market would see how good the business was, and then the rest could be sold for more later.

And so it turned out. At €14.50 a share, the November 2005 offering raised €500m. With a free float approaching 60%, Praktiker was able to deconsolidate from Metro and was guaranteed early admittance to MDAX, Frankfurt’s mid-cap index, which boosted the stock’s liquidity. The shares traded up.

Metro makes early sale

The sale had been subject to a six-month lock-up for Metro’s outstanding holding. “Metro had made clear that this was not a long-term strategic holding,” says Mr Radford. “The run-up in the share price and the latent investor demand encouraged the company to sell the balance earlier rather than later.”

The other joint bookrunners, ABN AMRO and Deutsche Bank, agreed to waive the lock-up and in April 2006 the remaining 40.5% was sold within a matter of hours. The price was €21. “It was as easy as the IPO was difficult,” one of the bankers involved was reported as saying.

Strategic ambitions

As a stand-alone company, Praktiker was then free to pursue its own strategic ambitions and to finance them itself. It had a healthy balance sheet: the offer had included a tranche of primary shares, which raised about €120m in additional capital for the chain store. As it happened, its own sale had stirred the German DIY market into action and a privately owned competitor, Max Bahr, agreed to sell out to Praktiker.

“Our corporate finance professionals had worked with Praktiker management on the sell-side,” says Mr Radford. “They had built a good relationship, and Praktiker asked us to advise on the acquisition and how to finance it.”

The price paid for Max Bahr has not been disclosed, but was thought to be €200m-€250m. This was partly funded out of cash and the proceeds of a €150m convertible bond offer in August. Various funding options had been considered. “Convertibles were the cheapest and fastest method,” explains Monika Weiler, JPMorgan’s head of Europe, Middle East and Africa equity-linked origination.

“Using existing credit lines reduces flexibility. Going back to the equity market would have caused immediate dilution. And a straight bond would not have been as straightforward as it sounds, because Praktiker has no official credit rating. That would have made it much more expensive for Praktiker.”

Praktiker announced the acquisition halfway through August and then waited a week to see what would happen to its share price. With JPMorgan and Deutsche Bank as joint leads, the convertible issue was then launched with guidance of 2.25%-2.75% on the coupon and 35%-40% on the conversion premium. One unusual twist was that the company retained the right to call the bonds early if the Max Bahr acquisition did not go ahead.

Market enthusiasm

Although this was still deep in holiday season, the market liked what it saw. The book closed within a few hours with the issue many times oversubscribed, and the final deal was on the best terms for the company: 2.25% coupon and a conversion price of €33.77, or a 40% premium.

“The convertibles market is very binary,” says Ms Weiler. “Either an issue works and you get good terms or it doesn’t work at all. It very rarely falls in between. A straight bond would have been priced at around 5.45%, so this was a good deal for the company. And shareholders are not diluted unless the price rises by a further 40%.”

The share price held up well during the placement and subsequently rose by nearly 5%. Given that the convertibles represent more than 10% of the company’s market capitalisation, that was a satisfying achievement. “Following its success in the equity markets, the company has now set a new benchmark, which is a very important step for it,” says Mr Hessberger. “With the convertible, it now has a position in the debt market, on very aggressive terms.”

In a neat postscript to this chapter of JPMorgan’s relationship with Metro, the bank placed another 5% of Metro’s shares with institutions via club-accelerated bookbuild in September. Worth €752m, they were sold by the charitable trust of the Schmidt-Ruthenbeck family, one of Metro’s largest shareholders. Seamless service continues.

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