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.”

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