Deutsche Bank has worked on all three pillars of ABB’s tripartite
corporate action plan – only the second of its kind to be implemented Geraldine Lambe reports on how the market’s negative perceptions of the firm have been reversed.
Fallen angels have hardly been a rarity in the corporate landscape in
the past couple of years. Less frequent have been dramatic falls from
grace with emergence from the ashes coming less than a year later, as
has happened in the case of Swiss-Swedish engineering group ABB.
At the end of 2002, ABB, which was previously hailed as Europe’s answer
to GE, stumbled close to bankruptcy after a string of acquisitions and
was virtually written off by financial markets. In January this year,
its credit default swaps (CDSs) were trading at about 1800 basis points
over Libor and its credit rating had sunk to junk status. Now the
company’s fortunes are looking considerably brighter: last month
Moody’s and Standard & Poor’s changed their outlook to positive,
the company’s share price rose 9% in one day and its CDS spreads
tightened to about 275bp over Libor. There is even some hope that it
may soon regain its investment grade standing.
On an upward trend
ABB’s upward trend perhaps comes as little surprise because it has
spent most of this year restructuring and has been rewarded by improved
operational performance in the past few quarters. Hopefully, the
company’s asbestos woes will be largely behind it, if its pre-packaged
settlements in the US get approved. However, the company did announce a
$279m Q3 loss – albeit due largely to write downs and exceptional
factors related to its restructuring and the US asbestos litigation –
and will miss its full year profits and debt reduction targets.
The key, therefore, to ABB’s most recent improvement in fortunes is the
three-pillar capital strengthening programme it announced at the end of
October. The programme consisted of a $2.5bn rights issue, a $1bn loan
from 12 relationship banks and an eight-year bullet, 6.5% E650m bond
issue. The timing was calculated to optimise the market’s positive
response to the company’s affirmative action during the past year.
Deutsche Bank is the only firm to work on all three pillars. Aptly
named the Phoenix Project by Deutsche, it is only the second of its
kind to be put in place. The first, also led by Deutsche Bank, was
undertaken for HeidelbergCement in July this year. “It was this package
that underscored the power of a three-pillar structure in helping
companies to achieve a cost-competitive capital structure. More deals
of this nature will happen in the future,” says Edward Chandler,
managing director, global corporate finance at Deutsche Bank, and the
senior investment banker on the deal.
ABB was faced with a heavy maturity profile. The rights issue at once
deleverages the company and spreads out its capital structure; as such,
it will enable the company to be less dependent on the markets and more
able to rely on operating profits. Brian Bassett, managing director,
high yield capital markets, says: “This package is not a quick fix. It
is designed to give the company a strong balance sheet for the medium
to long-term. It gives the company the flexibility to focus on its
business strategy and not its balance sheet.”
Focus on fallen angels
According to Guy du Parc Braham, director, leveraged finance, debt
products group, this sort of deal structure also reflects the effort
that Deutsche Bank has focused on the complex needs of fallen angels.
This year, for example, the bank has worked on a E345m convertible bond
and a E1200m loan facility for Royal Numico, and other transactions for
Fiat. “The ABB deal is the culmination of all these efforts. It has all
the products but on a size and scale not seen before,” he says.
Craig Coben, managing director, equity capital markets, agrees and says
that a successful solution depends on the right sort of bank
organisation. “For companies with these sorts of issues, you have to
come up with a holistic solution. You cannot afford to be stuck in your
product silos. Deutsche Bank has the co-ordinated approach, the product
sweep and the balance sheet to support such deals.”
It is the interrelationship between the pillars that met the company’s
needs and drove market support for the overall transaction, says Mr
Chandler. “While each element is independent, there is a mutual
reinforcement between each pillar of the transaction that, overall,
produced the best result for the company. It was clear that the equity
market would not bail out the bondholders or the banks unless the banks
were willing to renew their commitment to the company.
Creation of a virtuous circle
“Equally, there had been a downward spiral over the last two years in
how the debt markets perceived the company, given the low price of its
equity. We therefore needed to reverse this spiral and create a
virtuous circle between ABB’s equity and debt,” he says.
Although the full underwriting by the banks was crucial in persuading
investors that ABB’s supporting banks had absolute confidence in its
strategy, Mr Chandler says that the capital programme would have been
impossible to envisage if the company itself had not made such great
strides – particularly with its disposal strategy, on which Deutsche
Bank is also an adviser. “ABB has demonstrated that it is well advanced
with its disposal programme. It also laid out plans for further
transactions alongside its Q3 results and has had several quarters of
positive performance. The market has responded very well to all of
these developments,” he says.
The bond markets’ reaction was swift; within days, spreads had moved in
by 100-125bp. Equity investors have been positive, too, despite the 45%
dilution that the rights issue caused. But, then again, the capital
market’s relief at evidence of ABB’s recovery was evident as soon as
the company issued its E1bn convertible bond in August. On the day of
the issue, the share price rocketed by 14%, which is almost unheard of
with a convertible bond, says Mr Coben. He believes it illustrates how
much investors appreciate the firm’s reduction in risk.
“The risk premium diminished with the convertible bond and with this
latest programme it has diminished even further. Shares rose and
spreads tightened immediately. It clearly shows that investors are
prepared to be diluted in order to reduce risk – as long as the company
is seen to be getting stronger,” says Mr Coben.
Without doubt, the equity issue lay at the heart of the deal. “Without
that we would not have got the support of the banks,” says Mr Chandler.
It was also central to creating the virtuous circle needed to bring off
the transaction because, with the underwriters on risk, investors were
then convinced that participating banks were confident that ABB was on
the right track.
One of the major challenges for the underwriting banks was risk
assessment on the combined transactions. “We are on risk across all the
products so the process had to be exceptionally rigorous,” says Mr
Coben.
It was also a question of achieving the optimal balance sheet strategy
for ABB and balancing that with what the market would take in terms of
products, price, size and timing. Mr Coben says these requirements were
not strictly matched and they had to find the overlap. “But we have
been rewarded by the emphatic endorsement of the market,” he says.
Had the market’s reaction to the first pillar been different, the
prospects for ABB to execute the rest of the programme as successfully
would have been slim. On the debt side, for example, Mr du Parc Braham
says that Deutsche is looking for a re-rating on the basis of the new
equity being raised. “We are underwriting the bank loan and will be
doing the bond, and the key consideration in our ability to execute the
transactions on attractive terms is the restructuring and capital
changes enabled by the new equity.”
Tense times
There have been some tense moments for the Deutsche team. They were
initially working on a two-pillar package in January, which they were
planning to execute mid-year, but successive delays to the resolution
of outstanding asbestos litigation in the US meant that it was no
longer feasible. However, Mr Chandler says that the setback ultimately
worked in ABB’s favour. “ABB had more time to develop a track record on
its operational performance and its disposal programme. This had a very
positive market impact.”
Investor response to a deal cannot be predicted nor taken for granted,
Mr Coben says. “When we did the earlier convertible bond, the night
before, our hearts were pounding. It was the same this time: until you
announce a deal, you have no idea how the markets will react, no matter
how carefully you prepare the ground. When you are on risk it is
particularly important.”