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Skies Clearing

In a year of patchy recovery for Europe's capital markets, a clutch of landmark corporate deals stood out.
Poul Funder Larsen and Tony McAuley, CFO Europe Magazine
December 30, 2003

After two lousy years in succession, 2003 at last gave hope that the storm clouds may be passing for Europe's corporate capital markets. But the year certainly did not start out well, dominated as it was by the war in Iraq.

The trajectory of the FTSE Eurotop 300 index — tracking the shares of Europe's largest 300 companies — tells the story. The index's long, sharp decline from the 1,700 bubble-market peak in late 2000 continued into the first quarter of 2003, with a slump in March to 675 as the war in Iraq was officially declared.

In the first quarter, Europe-wide figures for equity capital markets were bleak, even compared with the depressed standards of 2002. Indeed, the first quarter of 2003 was the worst for new equity issuance since 1995, with a total of just €6.5 billion, according to Dealogic, a corporate finance analytics firm.

It was in the throes of this bear market, and on the first day of the war, that Allianz, the German financial services giant, bit the bullet and launched a €4 billion equity rights issue, the largest ever fully-underwritten rights issue. It was quickly overshadowed by France Télécom and its record €15 billion rights issue (which had the added advantage of being 56.5 percent underwritten by the French government, the subject of a European Commission probe for unfair state subsidy).

Baghdad Bounce
At the time, no one could have known that March would mark the beginning of a recovery. But after the swift fall of Baghdad, the FTSE Eurotop 300 began a steady rise towards 930, where it stood in late November. Those taking up Allianz's rights at the deeply discounted price of €38 — and take-up was 99.7 percent — have been rewarded with a stock price rise to €95.

The deal set a tone of decisiveness for new CEO Michael Diekmann. Though much comment was negative at the time it was launched, the success of the issue when subscription closed six weeks later was one of the factors that shook the market out of its malaise and gave heart to other companies.

Encouraged by the success of the jumbo rights issues in the spring, and riding the stockmarkets' so-called Baghdad bounce, new offerings picked up. Even so, by early November total new equity volume was still just €70 billion, compared with €81 billion for the same period last year, says Dealogic.

And while rights issues were up by 48 percent, at €26 billion, by November, IPOs remained slack — they were down by 47 percent, with 65 deals totalling €4.7 billion. Germany, for example, had to wait until October to have its first IPO of the year — the spin-off by HBV of Hypo Real Estate. But it was worth the wait — the IPO was well received, and the stock gained close to 20 percent in the first week after its debut. In the UK, pickings were also slim — the highlight was July's €1.64 billion listing of telephone directory group Yell, marking the largest IPO on the London exchange for two years. Yet quite a few exchanges, including Copenhagen, Oslo and Athens, didn't have any IPOs, at least none that managed to grab headlines.

M&A's Slow Takeoff
Mergers and acquisitions remained depressed. The total value of deals above €100m up to November was €396 billion, down 15 percent year on year and just a third of 1999's €1.2 trillion bonanza. But a few important deals were seen as harbingers of an upturn.

Among the European M&A deals that held promise of things to come was Air France's €784m (and very complicated) bid to take over Dutch carrier KLM in September. It was a sign that pressure from no-frills airlines is forcing Europe's bloated airline industry to consolidate.

In Germany, the end to a drawn-out battle for the ownership of Beiersdorf showed that consolidation in other sectors is going to be a lot trickier. For a large part of the year, the Hamburg-based owner of Nivea lotions was caught in a tug of war between German coffee trader Tchibo — already owners of a 30 percent stake in the cosmetics and healthcare firm — and Procter & Gamble of the U.S., which was fresh from its successful €4.7 bid for Darmstadt-based Wella. Backed by the city of Hamburg's investment fund, Tchibo beat Procter & Gamble, paying €4.4 billion in October. It might not be a done deal, however — some minority shareholders are balking at being excluded from the tender negotiations and raised the alarm at German regulators BaFIN.

Moving eastwards, however, all eyes have been on Russia and its ongoing bid to develop a mature capital market. In April, the country's largest oil producers, Yukos and Sibneft, merged to create the world's fourth largest private oil firm. But the arrest of Yukos's CEO, Mikhail Khodorkovsky, in October following allegations of fraud and tax evasion showed just how volatile Russia can be. And though Russia's president Vladimir Putin and prime minister Mikhail Kasyanov tried to mollify Yukos's shareholders and the rest of the business community, it's clear that YukosSibneft's travails will continue well into 2004.

Volatility Rules
Unsurprisingly, amid volatile equity prices, companies continued to sell convertible and exchangeable bonds. From the beginning of January to the end of October, total issuance of exchangeable bonds alone was €35 billion, well up on the €20 billion issued in the comparable period of 2002. The largest deal in that segment came from KfW, the German government-owned development bank — a €5 billion bond, convertible into stock in Deutsche Telekom.


Above all, it was a solid year for debt, with steady deal flow amid record low interest rates. That helped boost demand for high-yield issues. There was a slew of successful issues from former investment-grade high-fliers known as "fallen angels," such as Heidelberg Zement (€700m in July) and Vivendi (€500m and $585m, also in July). Telecommunications credits also showed signs of recovery, when in July Ireland's Eircom launched the first major high-yield issue from a telecoms provider since early 2001. The issue — a record for Europe's junk bond market — crowned a comeback year for the sector, where yields fell by half in 2003. Peter Lynch, Eircom's CFO, says the company had planned to sell bonds primarily in America. But with that market pricey by the time Eircom issued in July, "the European dimension was crucial," he says.

Bonds from unrated issuers also came into vogue. Heineken's October €1.1 billion two-tranche bond went down well with investors, suggesting good prospects for unrated borrowers with a strong "brand" and good credit story.

Overall, corporate bond issuance in Europe — excluding banks and financials — was €156 billion up to mid-November, up two-thirds on the same period a year earlier.

Assessing the corporate mood towards equity as opposed to bond capital markets, Tom Tourbridge, a partner at PricewaterhouseCoopers, says, "More companies are talking about coming to the equity market, but there is a sense that in the last two or three years, companies had found other ways to finance their activities." With low interest rates, he adds, companies have been turning to the bond markets — conventional, structured and high yield. Also, the venture capital industry has been financing a lot of deals with debt. "We are awash in debt," he says. —Poul Funder Larsen

The Allianz Odyssey
Navigating banks, hedge funds, a bear market and a war, Allianz launched a record equity rights issue.

Last spring, Allianz, the world's fourth largest financial group, could hardly have had worse timing. At a press conference on March 20th — the day the Iraq war started, and in the midst of the equity bear market — new CEO Michael Diekmann not only had the unhappy task of announcing the German company's first loss since World War II. He also used the conference to unveil the firm's plans to launch the largest ever fully underwritten equity rights issue.

The move was considered by many observers to be audacious, if not foolhardy. "The dilution effect is massive and the future business Allianz will have to generate to compensate for that is huge," groused Henning Gebhardt, head of German equities at DWS Investments, at the time.

But by the end of April, Diekmann and his finance crew were able to breathe a sigh of relief. The rights issue turned out to be an outstanding capital-raising exercise, one that helped lift Europe's financial services sector from its deep slump and restore investor confidence. Along the way, Allianz also hung on to its all-important double-A credit rating.

On the Edge
Investors had known about the perilous situation at Allianz for some time. Dresdner Bank, which it bought in 2001 for €23 billion, had run up €2.2 billion in bad debt from corporate bankruptcies, and the entire group had €5.5 billion of write-downs from stockmarket losses in 2002. Its loss in 2002 totalled €1.2 billion, compared with a 2001 profit of €1.6 billion.

"We saw a rapid decline, not only in our stock," says Stephan Theissing, head of corporate finance at Allianz. "But the whole financial sector was in danger of losing investor confidence." As the size of the 2002 loss became clear, "the ratings agencies began urging us to do something about our capital. We were keen not to do anything that would ultimately result in a loss of our double-A. I wouldn't have taken a risk with the rating."

Theissing soon found out that doing so would require months of tough negotiations. While preparing documentation for the rights issue, and with war looking inevitable, Allianz had insisted on changing the standard, all-encompassing force majeure clause in the contract with its underwriting banks — Deutsche Bank, Goldman Sachs, UBS and Citibank — so that a war in Iraq was excluded as an excuse for the underwriters to pull out of the deal.

The deal was set initially at €4 billion, with a deeply discounted price of €30 a share — a whopping 54 percent below the prevailing share price. The aim was to raise a minimum of €3.5 billion of new capital. "But clearly the price was too low," says Theissing.

"Then, of course, when the war started the banks got very nervous, but we were lucky enough to have this force majeure exclusion," says Theissing. "And the hedge funds were shorting our stock. In that environment, it was very tough negotiating with the banks."

But negotiate they did, some sessions lasting through the night as Allianz pushed hard for an increase in the subscription price, a bold tactic in the circumstances but one that paid off: the rights discount was cut to 26 percent and the total amount of the issue was raised to €4.4 billion.

"Once it was announced that the subscription price was increased to €38, the whole sentiment around the issue changed in our favour," says Theissing. "Market sentiment was, 'If they can manage to get the banks to agree to €38, there must be substance behind the whole transaction'."


The placement was clearly on its way to becoming a success. "There were a lot of shorts out in the market that made it a self-fulfilling prophecy," says Theissing. "It was a turbo effect, and the result was that the stock outperformed everybody else." Better still, he adds, "our operating earnings have recovered and the whole sector has been re-rated."

In November, Allianz announced that its capital position for the first nine months of the year had improved by €5 billion to €28 billion and that equity capital had increased to €26.3 billion from €21.7 billion at the end of 2002. More importantly, its economic capital deficiency at the time of the deal was €2.2 billion; now it's in surplus, at €10 billion.

Allianz's shareholders have reason to be pleased — shares have risen by 138 percent since the low of €41 at the time the rights issue was announced, to around €95 towards the end of the year.

The underwriting banks are happy too, having received whopping fees of 3.8 percent of the value of the deal, much higher than the standard 2.6 percent. But Theissing says, "Even with hindsight, I'm happy with the fees. It allowed us to take the subscription price to €38. The decision that had to be taken at the time was to minimise risk. It couldn't have been taken any other way." —Tony McAuley

End Game
Yukos's takeover of Sibneft created one of the world's largest oil companies — it has also become a test for Russia's capitalists.

It's not usually the case that the architect of the year's most remarkable merger ends up in jail just weeks after putting the finishing touches to the deal. But that's just what happened in Moscow following Yukos's $15 billion (€13 billion) takeover of local rival Sibneft in the spring of 2003. By the autumn, Yukos CEO Mikhail Khodorkovsky was in jail accused of fraud and tax evasion. He resigned as CEO in November, though he retains a 26 percent stake in the company, and he may run in the Russian presidential election in 2004. To top it all, the deal itself was put into a typically Russian-style state of limbo in late November, when Sibneft said it wanted to unravel the deal. Whatever the outcome, YukoSibneft is a watershed for corporate Russia and was the deal to watch in 2003.

Apart from its broader significance, the YukoSibneft combination creates one of the world's most strategically important oil companies. The west Siberian giant controls more than a quarter of Russia's oil extraction, with daily output of 2.3m barrels and reserves of 18.4 billion barrels, the largest of any non-state oil company in the world. It also owns six major refineries, as well as 2,500 retail stations. "Yukos is the only Russian oil company that can challenge the international majors," says Eric Kraus, chief strategist with Sovlink Securities, a Moscow investment house. It is no wonder, then, that industry number-one Exxon, among others, has been in talks to acquire a stake in YukoSibneft.

Strategic Player
Though Bruce Misamore, YukoSibneft's CFO, declines to comment on Exxon (or on his former boss's arrest), he agrees that, "the takeover created an entity that can take on larger, potentially riskier, projects and act on the international scene."

Misamore, an American who worked for two decades in the U.S. oil sector before joining Yukos in 2001, recalls how quickly the deal came together. "The deal was completed in July," he says. "Six months all in all, including due diligence."

It started out as informal discussions in February between Khodorkovsky and Roman Abramovich, then Sibneft's largest shareholder, and now a celebrity in the UK after his £150m (€215m) takeover of London's Chelsea football club.

By early April the broad parameters had been worked out between the two, and on April 22nd Yukos and Sibneft announced eastern Europe's largest industrial merger.

One reason why the parties could move so fast was "Yukos had a substantial amount of cash that could be used for the transaction," says Misamore. Prior to the deal, in fact, the firm was sitting on a cash pile of $1.9 billion.

"The deal was structured so that it allowed Abramovich to cash out," adds Sovlink's Kraus.

In order to minimise dilution, Yukos spent $3.7 billion on a share buyback, Misamore explains, that put the company on track to hit a net debt target of $5 billion for 2003. "We wanted to lever up the company from what was basically a very low level of gearing," he says. By October 3rd, Yukos had finalised the acquisition of 92 percent of Sibneft stock for $3 billion in cash and a 26 percent stake in the combined company, making an unwinding of the deal seem remote. "We'll come out with an offer to minority shareholders," Misamore says.

See-Through
In recent years, Yukos has emerged as one of Russia's most shareholder-friendly companies, adopting IAS accounting and an open information policy. In keeping with this, all documentation for the Sibneft deal was in English, in accordance with English law, says Misamore.

With the turmoil caused by Khodorkovsky's arrest, and Sibneft's cold feet, there is a lot riding on the success of the deal — one that has far-reaching implications for the development of corporate Russia. Its fate likely will set the terms for the relationship between government and business for years to come.


And, observes Sovlink's Kraus, "nothing that has happened subsequently has impaired the rationale of the deal." —Poul Funder Larsen

Dublin Calling
Eircom's record €1 billion bond issue was a milestone for Europe's junk bond market.

Eircom has become something of a bellwether for the European telecom sector. At the end of 2001, the current owners — a consortium led by Irish businessman Tony O'Reilly — took it private in the first leveraged buyout of a European fixed-line telephone company. And in 2003, a junk bond issue was the key plank in the consortium's refinancing of the buyout's initial €2.4 billion of bank loans.

Launched in July, the €1.05 billion issue grabbed headlines as the largest-ever junk bond by a European firm, and its success underlined the revival of the high-yield eurobond market after a two-year slumber. Also, with €446m of the funds raised going to pay a special dividend to the investors, the financing was hailed as a model for private-equity financiers looking for alternatives to selling equity as a way to take cash out of their business.

Eircom's bonds had a lot going for them. The size meant excellent liquidity; and Eircom was the only incumbent fixed-line telecom issuer in the sector, giving it "scarcity" value. On top of all this, because its rating of BB+ is just one notch below investment grade, Eircom saw a lot of demand from crossover investors who wanted to include less-than-investment grade bonds in their portfolios.

For "fallen angels" — former investment-grade companies that now have junk status — new financing options have opened up. "It's not just dedicated high-yield buyers any more," says Matthew Cestar, executive director of European high-yield capital markets at Goldman Sachs. "We're seeing the confluence of a variety of different fixed income investors."

At the beginning of the year, the junk bond market hardly looked promising: only €5 billion of new bonds were sold in 2002 — three to four times less than the volumes in the heyday of 1999 and 2000. Peter Lynch, Eircom's CFO, wasn't too optimistic at the time. "We didn't really expect to do the refinancing," he concedes today. But once the market started improving, Eircom and lead underwriter Deutsche Bank moved fast. "We decided to refinance in May. Twelve weeks later we did it."

By late July, the prevailing wind was blowing in Eircom's favour. According to Lehman Brothers, average European junk bond yields fell by half, from over 18 percent in October 2002 to less than 9 percent at the time Eircom sold its bonds. As well as broadly lower European interest rates, junk bonds pushed down their yield premiums over government bonds, to an average 500 basis points over government bond yields.

At the time of the offering, Eircom was also €600m ahead of plan on cash generation, Lynch says. And despite revenue stagnation, the European fixed-line industry remains highly cash-generative — a major factor in attracting the "crossover" bond investors.

The bonds were sold at yields about half what they might have been just a few months earlier. The offering consisted of €550m of senior notes with a 7.25 percent coupon, as well as €285m and $250m in subordinated notes with 8.25 percent coupons.

But Eircom did get a surprise. Initially, the company expected most demand to come out of the U.S., but it was actually Europe that saved the day. "We found ourselves in the U.S. chased around by other high-yield issues," Lynch says. "In the U.S. we would have been pounded on price." Instead, says Lynch, "we could have filled the whole bond from Europe. The European dimension was crucial." —Poul Funder Larsen

Dog of the Year

Who would have thought that the shifting habits of Britain's couch potatoes could harpoon the investment banking dreams of a major German financial group? But the unravelling of WestLB's securitisation of UK TV rental firm Boxclever — resulting in the resignation of the bank's CEO, the restructuring of its investment banking activities, not to mention a probe by bank regulators — is CFO Europe's choice for deal fiasco of 2003.

It seemed to start so well. Back in 2002, WestLB's Principal Finance Group and its suprema, Robin Saunders, who had risen to financial fame with deals for Formula One, were lauded for masterminding yet another brilliant deal. Having financed the combination of a large part of the British TV rental business into a new company, Boxclever, they securitised the loans into £748m (€1.08 billion) of bonds backed by rental income. The ratings agencies gave the biggest tranches of the bonds investment-grade ratings.

Problem was, the TV-rental business has been in terminal decline. On top of that, a repairs unit under Boxclever got into serious trouble, leading to the loss of major wholesale customer orders. The bonds were soon downgraded three notches by Moody's and remain on watch for further cuts by the agencies.

For WestLB the fallout has been massive. A €650m write-down on the deal was a big factor in WestLB's resounding €1.7 billion loss last year and brought down its CEO Jürgen Sengera in June. As a result, WestLB is looking to sell its Panmure UK broking arm before the end of the year. Not only that, WestLB's losses have raised eyebrows among German regulators, who were preparing a report as this magazine went to press. The £20m arrangement fee the Principal Finance Group received for structuring the deal sure wasn't worth it.




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