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Lackluster investor demand and shelved deals have marked another bleak year for corporate Europe.
Ian Rowley, CFO Europe Magazine
January 1, 2003
After a difficult end to 2001, CFOs in Europe began 2002 amid predictions that a backlog of postponed deals would kick-start investment activity. Instead, corporate scandals, falling asset prices and weakening investor confidence have left CFOs facing the worst deal- making environment in years. "The lack of confidence has continued," says Heino Teschmacher, co-head of M&A at UBS Warburg. "People were saying that 2002 would be better, but in general terms that just hasn't happened."
For evidence take a look at the equity-linked bond market. Exchangeables and convertibles had been hot in 2001, rising in value from E31 billion in 2000 to E50 billion, according to Dealogic, a provider of financial data, and there was enough reason to believe that their popularity among corporate financiers would continue in 2002. Zurich Financial Services, German chip maker Infineon Technologies and Publicis, a French advertising and media services conglomerate, all thought so and went to market with equity-linked bond issues in January.
There were even some bold variations of traditional equity-linked deals. For example, Zurich's index-linked bond, dubbed Market Index-Linked Exchangeable Securities (or Miles), involved issuing three-year securities linked to the performance of Switzerland's SMIC share index. (See Dealwatch, February 2002.) Investors could choose to convert the securities into new Zurich shares six months after the launch of the issue or wait until they were converted automatically on maturity.
The number of shares issued depended on how the firm's shares perform in relation to the SMIC index. If Zurich's performance matched the index, the company would issue 1.5m new shares. But if Zurich's stock price under- or out-performed the index, the number of new shares issued would fall or rise—up to a maximum of 3m, or 3.6% of total capital. The better Zurich's share price performance relative to the index, the less its equity base would be diluted.
When the SFr600m (E415m) deal was launched in January, Zurich's then-CFO Günther Gose swooned that Miles "strengthens our balance sheet by increasing our equity, provides liquidity and reflects our confidence."
By summer, however, that confidence began to evaporate. Zurich's share price tumbled 25% in early July to SFr210 as the financial-services sector fell out of favour with investors. What's more, concerns grew about the dilution of Zurich's shares as the date at which investors could convert their Miles approached, further weakening Zurich's share price. In September, a company press release announced that "substantially all of [the Miles] have been exchanged into new shares."
Other companies have also grown disillusioned with convertibles. British utility International Power, for example, is among the companies that issued short-dated convertible bonds at the height of the stockmarket boom and is now preparing for cash pay-outs as share prices remain in the doldrums. IP's convertible bond issued in November 2000 includes a put option, which is likely to be exercised in November 2003 unless its share price increases significantly in the coming months. David Crane, CEO at International Power, told reporters in October that the company now assumes that bonds will have to be repaid to the tune of E353m.
Credit Suisse First Boston predicted in October that Europe's equity-linked market will shrink 16% during 2003 as redemptions outpace new issues. This trend is already under way in the US, where the value of the market has fallen from a peak of $237 billion to below $200 billion.
"The bottom line is that share prices need to rise and credit spreads need to narrow for a sustained period," says Lorraine Lodge, head of convertible research at ABN Amro in London. "If that happens you will see new issuance. If it doesn't, you won't."
The rest of the corporate bond market hasn't fared better. By mid-November, new corporate debt issuance in Europe reached E280 billion, compared with E441 billion for all of 2001 and E343 billion for 2001. Why the dire performance? Look no further than the corporate scandals on the other side of the Atlantic, says Martin Hibbert, a managing director of debt syndicate at Deutsche Bank in London. "Things were looking good at the start of the year, but WorldCom had a massive impact on the market," he says, noting that European investors held a sizeable amount of the US telecom firm's bonds. "[Events at Worldcom in March] had repercussions on the ability of companies to execute new deals and how investors saw the market. You could make a point that the market is only just starting to recover."
The year was dominated by safe bets, involving companies with solid credit ratings from strong sectors. For example, Bayer, the single A-rated German chemical giant, raised E5 billion in April after receiving over E10 billion of orders. The firm's initial intention was to raise E3.5 billion to refinance its E7.5 billion acquisition of Aventis CropScience in 2001. Deutsche Post World Net was another firm that successfully tapped debt investors—with its first-ever bond, the German postal giant raised E1.5 billion in the autumn.
The rights stuff
In the equity markets, the big story over the past year was found among the rights issuers. "For distressed companies, [rights issues] are financing of the last resort," says Jim Renwick, head of European equity capital markets at UBS Warburg. He notes that for indebted companies struggling to raise more debt or make asset disposals, deeply discounted rights issues are one way to repair their balance sheets. "Right now, there are a lot of companies in that position."
To the end of October 2002, rights issues accounted for 23% of all equity issuance compared with 11% last year, according to UBS Warburg. The prize for issuing the largest deal of the year goes to Swedish telecom giant Ericsson, which raised E3.2 billion in July with a 74% discounted deal. Ericsson would have been upstaged if France Télécom, the debt-burdened French telco, had decided to go ahead with a massive E15 billion rights issue. Though those plans were shelved in October, France Télécom still isn't ruling out a share issue to pay down its debt, but that won't happen until the spring of 2003 at the earliest.
Accelerated equity offerings also featured large in 2002. Aegon launched the largest equity deal of the year when Aegon Association, the Dutch insurer's largest shareholder, placed 350m shares with investors in a single day. That trade, which was valued at E3.5 billion, was the equivalent of 59 days of trading volume. Aegon plans to use the funds to reduce its debt and strengthen its capital position.
By contrast, the market for initial public offerings in Europe has been going from bad to worse. Many companies were forced to revise plans to launch IPOs due to the volatile market conditions. In July, for example, Yell, the UK-based telephone directory company, postponed a £1.1 billion (E1.7 billion) public offering at a cost of £15m. The same month Prada, the Italian fashion company, and C&C, an Irish drinks group, also shelved deals.
The IPO market has barely picked up since. According to PricewaterhouseCoopers, during the third quarter, there were 34 IPOs in Europe totalling E1 billion, compared to 72 at a value of E5 billion over the same period in 2001. "The third quarter is always quiet, but this was worse than usual," says Tom Troubridge, a partner at PwC, noting that the threat of war in Iraq added to investor concerns.
All this makes the few successful IPOs of 2002 achieve star status. Several private equity investors sold stakes in companies through the equity market at the start of the year—in part because opportunities for other private sales or through M&A were even slimmer. Among them: Cinven and CVC Capital Partners, that majority owners of UK bookmaker William Hill, which launched an £735m IPO in June.
Indeed, cash-generative, old-economy companies were clearly back in vogue. Autoroutes du Sud de la France (ASF) was responsible for Europe's largest IPO in 2002, allowing the French government to raise E2 billion through an IPO privatising the toll road operator in March. "Investors want solid companies with stable cash flow, which is what they got with ASF," says PwC's Troubridge. Similarly, in July, Italian utility company ASM Brescia raised E333m with a primary equity offering.
What lies ahead? "There is one school of thought that investors will come back in January flush with cash to invest on some good quality offerings," notes PwC's Troubridge. "But that would be the golden scenario."
Is a "golden scenario" far fetched? Maybe not. Consider the hard-hit equity-linked market. It emerged from its enforced slumber in November when Parmalat of Italy, Vivendi of France and Russia's Lukoil issued convertible deals in quick succession. Growing investor demand even led Parmalat to increase the size of its deal from E175m to E210m. CFOs will be hoping it could be the start of something more substantial. But then, that's what they were hoping at the beginning of 2002.