Merrill Lynch’s singleness of purpose played a vital part in the Royal Bank of Scotland-led consortium’s takeover of ABN AMRO. And nowhere more so than in the Fortis rights issue, the biggest ever in dollar terms, which tipped the scales against all predictions. Edward Russell-Walling reports.

Investment banks may be heroes to themselves but real heroism is not often on display in the capital markets. There was, however, a distinct touch of the heroic about Merrill Lynch’s role in the consortium takeover of ABN AMRO and nowhere more so than in the enabling, gargantuan Fortis rights issue – the biggest ever in dollar terms.

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Takeover success: Rupert Hume-Kendall, Jean Dessain and Jim O’Neil.

Every other bank in town – well, at least nine of them – advised either ABN Amro or its preferred suitor, Barclays. ABN AMRO announced last March that it was discussing a white knight merger exclusively with the UK bank. Two months later, Royal Bank of Scotland gate-crashed the party with a €71bn bid, in concert with Santander of Spain and Belgium’s Fortis. Merrill was lone adviser to all three, lending a singleness of purpose that played an important part in the consortium’s eventual success.

Largest sum

Fortis, the smallest member of the group, had to contribute the largest sum of cash – €24bn – in return for ABN AMRO’s Dutch banking unit and private client and asset management businesses. It did not get the Dutch wholesale business, which went with other interests to RBS (which stumped up €27bn, though €5bn of that sum was in shares).

For Fortis to raise that kind of money was never going to be an easy task. “The first I heard of it was on a Sunday afternoon, when I had a call, asking what was the most equity we could raise for a company – no name – with a market cap of €40bn,” recalls Rupert Hume-Kendall, Merrill’s chairman of equity capital markets. “I said probably €20bn, with a 50% discounted one-for-one rights issue.”

Two days later, he and his team met the senior management of Fortis – which was, of course, the unnamed company – to discuss the best plan of attack. “There was a requirement from the Dutch regulator for us to demonstrate the certainty of funds,” says Jean Dessain, Fortis’s director of capital solutions. “One way we could have done that was to fund it well in advance, with a rights issue in May. But there was a risk that the takeover might not go through and we couldn’t take for granted Fortis shareholder support.”

At the time, the market at large (egged on no doubt by the Barclays camp) was sceptical about the consortium’s ability to raise the necessary cash and Fortis was seen as the weak link in the chain. But Merrill rode to the rescue by presenting Fortis with a standby underwriting commitment for €22bn – €17bn in equity and €5bn in hybrid debt.

“There had been a lot of noise in the market,” admits Jim O’Neil, Merrill’s head of corporate finance. “But once we provided standby underwriting it demonstrated to the regulator that the underwriting was there and showed the shareholders that the consortium actually did have financing capacity. The noise subsided.”

The underwriting commitment was signed in May. Fortis organised sub-underwriting with ING and Rabobank of the Netherlands and Italy’s Mediobanca, to the tune of $1.5bn each. “That showed the regulator that others believed in the transaction, that it was not just a dream between the consortium and Merrill Lynch,” Mr Dessain explains.

Commitments of support

Merrill made similar commitments to support future funding exercises by RBS (€6.2bn in Tier 1 capital) and Santander (€7bn domestic retail mandatory convertible bonds and a potential rights issue). With bid funds effectively in place, the Merrill capital markets team’s work was done for the time being and the consortium’s focus returned to the offer.

At this point, the plan was to fund Fortis’s share of the purchase with up to €15bn in rights issue equity, up to €5bn in new Tier 1 capital and €5bn to €8bn by means of capital release – selling non-core Fortis and ABN AMRO assets – and securitisation. The next phase from a capital markets perspective was to reduce the pressure on the Fortis share price. This was necessary because people were starting to realise that the consortium could actually win.

“As weight shifted from [Barclays chief John] Varley to [RBS boss Sir] Fred [Goodwin], Fortis’s share price fell,” Mr Hume-Kendall explains. “Jean [Dessain] came up with the idea of issuing €2bn in contingent mandatory convertible bonds to prefund part of the €15bn rights issue. By cutting it to €13bn, this could alleviate the pressure on the share price – and it did.”

These innovative ‘conditional capital exchangeable notes’ (CCEN) were basically floating rate notes that converted into mandatory convertibles when Fortis carried out its rights issue. If it didn’t they simply redeemed at par after one year. Launched in the second week of July, just as credit and equity markets were beginning to stumble, the issue nonetheless attracted €5.6bn of orders.

The success of the €2bn CCEN issue, with Merrill as sole bookrunner, was seen by the press as a turning point in the ABN AMRO bid story. “It sent a very strong signal about Fortis’s ability to raise attractive capital at short notice,” says Mr O’Neil.

The next hurdle was to get Fortis shareholder approval for the rights issue and the acquisition itself at EGMs in Brussels and Utrecht in early August. The increase in share capital being sought was the maximum permissible by law and a 75% majority was needed at both meetings.

At the same time there were fears that the opposing camp would buy Fortis stock to vote down the motions. The thundering herd hit the phones with an active campaign to explain the rationale of both the acquisition and the rights issue. It was an unqualified success and 95% of those voting approved the rights issue, while 96% supported the bid.

This set the stage for the denouement – timing and execution. By now, as Mr Hume-Kendall notes, market conditions for the banking sector had changed from uncertain to dismal. “It was a matter of judgement to get the rights issue into the right slot,” he says.

Taking into account the flat water following the Fed’s rate cut and the three-week window before the ABN AMRO shares would (with luck) have to be paid for, it was decided to go on the same day as the ABN AMRO EGM – 20 September.

The discount to the theoretical ex-rights price was set at 31.7% and terms of the two-for-three issue were announced the following day.

“It was crucial to get the pricing right, so the stock couldn’t come under attack,” Mr Hume-Kendall points out.

Too narrow a discount could have sparked a wave of short selling by hedge funds. “But,” says Mr Hume-Kendall, “Fortis shares closed up on the day of the announcement and traded up 15% between the launch and the close.”

Merrill Lynch had decided not to seek any further sub-underwriting so, with billions at risk, its commitment to the transaction’s success was strong to say the least. However, that decision was to send another powerful signal to the market, which decided that the shares were cheap.

“Our refusal to flinch at any point was absolutely critical to success,” Mr Hume-Kendall maintains.

More than 80% of the rights were traded during the subscription period and the €1.9bn rump was placed at a premium to the last closing price in a book that was five times covered in less than an hour. The issue had raised €13.4bn, at a time when banks were deeply out of favour.

Transformational

A few days before the end of the subscription period, Barclays withdrew its offer and the consortium bid went unconditional the day before the rump placement.

In the language of the trade, it had been a transformational M&A funding transaction, helping to propel Fortis into a different peer group – the top one.

It has been hugely positive for Merrill Lynch too, of course, in terms of sole adviser fees and league table position. In investment banking, heroism is repaid with more than simple admiration.

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