Flexibility was vital for global coordinator Goldman Sachs to enable ArcelorMittal to raise capital through a dual-tranche equity and convertibles issue while preserving the ownership status of the Mittal family.

The fortunes of the convertible bond market wax and wane along with faith in equities, and in the depths of the past couple of years some predicted it would cease to exist altogether. As life returned to the equity market, however, 2013 got off to a record-breaking start for convertible issuance, led by ArcelorMittal’s $4bn combined offering of new shares and mandatory convertible notes.

As the world’s largest steelmaker, and a standard bearer of what used to be known as the 'old economy', ArcelorMittal has been having a rough time. Mittal Steel acquired hybrid European steelmaker Arcelor in 2006, borrowing heavily to complete this and other purchases, and it ended last year with debt of $22bn. But plummeting post-Lehman steel demand in 2009 poleaxed the Luxembourg-registered company, which has been trying to regain its balance ever since.

ArcelorMittal’s credit rating was downgraded to junk status last year by Standard & Poor’s and Moody’s, both of which cited a weakening steel market and doubts over the company’s debt reduction plans. After the Moody’s downgrade in November, the shares actually rose – investors believed that the risk of an unwelcome rights issue to support the investment grade rating had now gone away.

It was clear enough to the company, under chairman and CEO Lakshmi Mittal, that it still needed rather urgently to slash debt and costs. This was particularly so since, after a couple years on the mend, 2012 was turning out to be a disaster, with steel demand cooling in China and collapsing in Europe even as input prices continued to rise. Attempts to staunch the damage by closing European furnaces were partly frustrated by nationalisation threats from the French government and provoked violent strikes in Belgium.

Balance sheet repairs

Since mid-2012, the company has agreed the sale of various assets worth more than $2bn. It has sold a 15% stake in a Canadian iron ore mine operator to a consortium that includes South Korean steelmaker Posco and Taiwan’s China Steel Corp for $1.1bn. US steel distributor Skyline Steel has gone to Nucor for $605m, and a 50% stake in a South African manganese mine is being sold to partners in the venture for $447m.

“The divestments were part of a comprehensive initiative to strengthen the balance sheet and increase strategic flexibility,” says Brett Olsher, co-head of Goldman Sachs’ global natural resources group. “It included a $1bn-plus cost savings programme.”

The biggest contribution, however, was going to have to come from the capital markets. The company’s medium-term objective was to reduce net debt to $15bn ($17bn by June this year) and so, with the divestments and the cost savings, another $4bn in capital was required. ArcelorMittal explored its options with the help of Goldman Sachs, which has worked with the company since the time of the Arcelor merger. The bank advised Mittal at the time and Mr Olsher was on the Deutsche Bank team advising Arcelor. Indeed, the two companies are more than just client and adviser – Mr Mittal has been on the Goldman Sachs board since 2008.

The steel company needed to reduce its debt significantly, not just roll it over, so it was going to have to look for a solution to its problems in the equity or equity-linked markets. “We discussed a wide variety of different instruments, structures and timing scenarios,” says Alasdair Warren, head of European equity capital markets (ECM) at Goldman Sachs.

Family values

ArcelorMittal had been here before, in its annus horribilis of 2009. In March of that year, with net debt of $26bn, it raised €1.25bn via convertibles. The issue was well received, not least because it appeared to remove the threat of a mammoth rights issue. So the market was somewhat surprised when, little more than a month later, the company came back with a much bigger combined issue which raised $3.2bn in ordinary shares and $800m in convertibles.

A rights issue might conceivably have been one of the options for the latest capital raising but, apart from the traditional dangers involved, there was one rather personal difficulty. Before the latest transaction reduced their stake to 38%, the Mittal family owned nearly 41% of the business, so for them to take up any rights in full, or at least not to suffer significant dilution, would be forbiddingly expensive for them.

The issuer had to choose a receptive segment of the market and it had to get its timing right. One fresh source of equity capital for European companies had recently materialised across the Atlantic, where investors were rediscovering the equity-like yields but lower volatility of convertibles.

“We had seen particularly strong demand from US-based long-only investors for convertible instruments in other transactions,” says Antoine de Guillenchmidt, head of equity-linked origination and French ECM at Goldman Sachs. “We recommended to the client that the best way to get $4bn, on the best terms and with the lowest execution risk, was to take advantage of this specific market window.”

The bank also recommended a common stock tranche catering to the interests of existing shareholders, more than half of whom (excluding the family) were European long-only equity investors. As such, they could not buy the mandatory convertible in meaningful size.

Investor demand

ArcelorMittal was following in the tracks of German automobile manufacturer Volkswagen, which had reopened the mandatory convertible trail in November. Its €2.5bn deal (three-year notes paying 5.5%) was the first of its kind from a European company for more than two years, and uncovered a rich seam of interest among more traditional US investors.

Once the structure of the transaction had been settled, it only remained to decide on the timing. As 2012 drew to a close, equity markets rallied, cyclical stocks improved and ArcelorMittal’s share price was rising.

“We had an interesting debate over whether to wait until the full-year numbers were announced on February 6,” says Mr Warren. “We decided that we should take advantage of strong market conditions and raise capital sooner.”

The company’s shares are traded on various Euronext exchanges and in New York. The transaction was announced shortly after midday London time (7am in New York) on January 9, with Goldman Sachs acting as sole global coordinator and joint bookrunner alongside Bank of America-Merrill Lynch and Deutsche Bank. The shares, which had been in $13 territory in early November, were trading at $17.60. There was a briefing by management at 2pm.

“We recommended that they launched a slightly smaller deal size,” says Mr Warren. “So we announced a $3.5bn capital raising, reserving the flexibility to alter the tranche sizes, with more or less mandatory and equity, according to demand and to optimise pricing and execution. This, together with the flexibility as to where the family would subscribe, gave us the maximum number of levers to pull.”

Upsized deal

The announcement revealed that the family would subscribe $600m across the two tranches, although the exact proportion was not specified (it ended up split equally between them). The shares, which had been trading at about $17.60, fell as low as $16.65 but rallied on the US opening and by 2.30pm the books were covered. Over the next couple of hours demand rose to nearly $20bn, about 65% of it from North American investors.

“By 4.30pm in the UK we were in a position where we could start discussing whether we could upsize the deal, what the tranche sizes would be and our preliminary recommendations on terms and pricing,” Mr Warren recalls. The size was increased to $4bn, comprising $1.75bn equity and $2.25bn convertibles. The shares were offered at $16.75 and the coupon of the three-year convertibles was set at 6%, towards the tighter end of the marketing range of 5.875% to 6.375%. The maximum conversion price was at a 25% premium to the reference price of $16.75, corresponding to $20.94. The shares and convertibles both traded up initially but have since fallen back.

“A year ago this transaction would not have been possible at this size and level of demand,” says Mr Olsher. “This opens the door for many other companies in the sector to explore capital structure enhancements in the equity and equity-linked markets.”

The deal’s success displayed a high level of confidence in the outlook for equities. “It was an extraordinary statement about the market, showing optimism about economic recovery and a desire to re-weight into equities in a meaningful way,’ says Mr Warren.

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