Capital Markets

Deals of the Year, Europe

Investment bankers on the continent may have been on the defensive during 2001, but these three deals were real breakthroughs.
Ian RowleyJanuary 8, 2002

Call it a sign of the times. In October, Merrill Lynch offered 50,000 of its 65,900 global workforce voluntary redundancy. Other investment banks have been doing the same.

One look at a few statistics and the reason why is clear. According to Thomson Financial Securities Data, completed merger and acquisition deals in Europe for the year to mid-November came to nearly 10,000, down from nearly 15,000 during the whole of 2000. The cumulative value of deals also fell dramatically—to around E500 billion (US$448 billion) in 2001 from E1.2 trillion in 2000. Equity issuance has fared just as badly. The combined value of initial public offerings during 2001 through to mid-November was a mere E24 billion, compared with E105 billion for the entire previous year.

The Good News

While statistics paint a bleak picture, Europe’s capital markets haven’t been devoid of groundbreaking deals. In many cases, firms and their advisers have navigated difficult market conditions, often tapping new asset classes as traditional sources of capital ran dry. Telecom firms—weighed down by debt thanks in large part to the high cost of buying third-generation mobile phone licences—have been particularly busy, while utilities and financial services firms also list among the year’s most active deal-makers.

And unlike M&A and equity markets, Europe’s corporate debt market has flourished. Thomson Financial notes that corporate debt issuance in Europe rose to E190 billion through to mid-November compared to E150 billion during the whole of 2000.

“This has been the year when the euro-denominated market has really arrived,” says Martin Hibbert, a director of debt syndicate at Deutsche Bank. “The euro market now provides a viable alternative to the dollar market.”

Consider Deutsche Telekom’s bond issue in July. When Deutsche Telekom launched a E16 billion (US$14.3 billion) global bond in four currencies in 2000, only E3 billion was raised in the euro market. However, this year’s all-euro E8 billion jumbo issue was almost two-times oversubscribed. “They also got better pricing in euros than they would have done in dollars,” adds Hibbert.

What’s striking about Deutsche Telekom’s deal and others, however, is that investors are demanding added protection before buying bonds. In particular, step-up coupons— where the interest paid out on a bond goes up or down depending on whether a company’s credit rating changes—have become commonplace during 2001, especially in the second half of the year. “In troubled sectors where there’s a lot of volatility, investment bankers will advise companies to pay-up to get the deal out,” says Stephen Wilson-Smith, head of fixed income credit research at M&G Investment Management.

Securitization is another debt market on course for a record-breaking 2001. Mark Wilten, a director in asset securitization and principal finance at WestLB estimates that asset-backed issuance in Europe will total between E110 billion and E115 billion in 2001, compared to E92 billion the previous year. Wilten says the popularity of asset-backed issuance is two-fold. On the one hand, investor demand for low-risk asset-backed securities has increased as general market confidence has declined. On the other, corporates have turned to securitized debt as traditional forms of fund raising have grown more expensive. “People now see securitization as a mainstream form of financing,” notes Wilten. In June, for example, Telecom Italia raised E700m when it became the first telecom company to securitise telephone bill receivables.

Companies also made regular use of the equity-linked market during 2001, particularly at the beginning of the year when issuance reached record levels in Europe. Several months before its asset-backed bond, Telecom Italia issued an innovative E2.5 billion exchangeable bond, which was potentially convertible into shares of two subsidiaries—Telecom Italia Mobile and Seat Pagine Gialle—and carried a coupon of just 1 percent.

More Reasons to Be Cheerful

Unlike the booming debt market, however, the big deals that have characterized Europe’s M&A market in recent years have been few and far between in 2001. Yet amid the gloom several deals still stand out. Heino Teschmacher, co-head of M&A at UBS Warburg, points to a preponderance of large cross-border deals announced in the first quarter. A case in point: Vodafone’s acquisition of a 45 percent stake in Japan Telecom and control of its wireless subsidiary J-Phone.

Meanwhile, few industries in Europe have been more active than the utilities sector. In April E.On, the Dusseldorf-based energy giant completed a E8.3 billion acquisition of British rival PowerGen, establishing a foothold in the U.K. market and in the U.S. through PowerGen’s LG&E Energy subsidiary in Kentucky.

Financial services companies were also active. German insurance giant Allianz completed its acquisition of Dresdner Bank in September in a E23.4 billion deal, while U.K. banks Royal Bank of Scotland and Halifax announced a £28 billion (US$40 billion) merger to form HBOS in May.

All told, few aspects of corporate finance have suffered more than the equity market in 2001. Indeed, given that the FTSE Eurotop 300 index plummeted 34 percent from 1,512 in January 2nd to a low of 999 on September 21st, finance chiefs can be forgiven for delaying IPOs. Not least because of the high-profile E10.3 billion flotation in January of Orange, France telecom’s mobile phone subsidiary, which had to be re-priced to take account of adverse market conditions.

“It’s been a very rough year,” says Matthias Mosler, head of European equity capital markets at Merrill Lynch. “In terms of volume and profitability the industry has gone back two years.”

Nevertheless, for firms that braved the market, it hasn’t been all bad news. British Telecom successfully completed a record-breaking £5.9 billion rights issue in June as part of a raft of measures to reduce debt. (See page 35.) And Euronext, which was formed from a merger of the French, Belgian and Dutch stock exchanges in September 2000, used cash raised from its IPO in July for its proposed all-cash acquisition of Liffe, the London-based derivatives exchange.

Meanwhile, old economy companies have found a new lease of life. Take Statoil, the state-owned Norwegian oil company, which raised E3.3 billion in an IPO in June. Inge Hansen, Statoil’s CFO, is certain the company benefited from launcing its IPO during 2001 rather than the year before. “If we’d gone to market in 2000 during the dot-com bonanza, we wouldn’t have got any attention,” he says. But “by the time we launched our IPO, people had begun focU.S.ing on the fundamentals.”

Bankers add that the firm’s share price has performed relatively well since its IPO, which was four-times oversubscribed. “Given its performance compared to other companies in the sector, I think it’s been a very successful IPO,” says one banker close to the deal.

But UBS Warburg’s Teschmacher isn’t expecting the IPO market to surge in 2002 for all type of businesses. On the contrary, he suspects a number of companies will consider de-listing. He says that depressed stock prices and dwindling analyst interest in many small- and mid-sized companies could lead to more managers examining the costs and benefits of public listings. “I’m not saying the stock market is no longer the right place for these companies, but it’s certainly less exciting,” he says.

Not everybody is convinced, however. Rupert Hume Kendall, managing director of equity capital markets at Merill Lynch, contends that companies are more likely to attempt to increase their exposure to investors by pulling off big deals. Most bosses, he says, “would be more tempted to do a deal to make themselves bigger.”

One thing is clear: whatever the type of transaction—whether equity, debt or M&A—recession-hit investment banks will be glad of the business.

1. BT: CALLING ON SHAREHOLDERS

A rights issue helped the struggling telco reduce crippling debt, and paved the way for a successful re-structuring.

With 1.7m shareholders and more than 21 million domestic customers, it’s hardly surprising that BT, the £20.4 billion (US$29 billion) phone company, receives a lot of media attention. But this year BT has grabbed an even bigger share of the headlines than usual—and with good reason. In the past 12 months, the London-based firm has raised billions of dollars in asset sales, demerged its mobile phone business, cancelled a joint venture with U.S. telco AT&T at a cost of £1.4 billion, and accepted the resignations of both its chief executive and chairman.

One story, however, seems to have overshadowed the others. In May, BT carried out corporate Europe’s largest ever rights issue. Allowing it to raise £5.9 billion by issuing new shares and giving existing shareholders the right of first refusal, the heavily discounted deal raised came at a time when most other sources of finance were largely unavailable—or prohibitively expensive—to struggling telecom companies.

“In terms of conventional sources of financing, we were at the absolute limit,” recalls Philip Hampton, BT’s finance chief. “[The rights issue] enabled us to conduct our business in a normal way, rather than continually reacting to the short-term financial pressures on our balance sheet.”

Spend, Spend, Spend

Those financial pressures came in the shape of £29 billion of debt, largely built up during the late 1990s when BT splashed out cash for third-generation mobile phone licences across Europe and for a string of acquisitions. For Hampton, who joined BT in November 2000 to help the firm out of its predicament, the rights issue was more than just a way to pay down debt—it was also the key to restructuring the rest of the business.

Nonetheless, tapping equity shareholders at a time when investor sentiment was firmly against highly indebted telecom companies came at a price. For one, institutional investors held BT’s chairman, Iain Vallance, responsible for the company’s perilous financial position and so demanded his resignation in return for backing the rights issue. In April, he was replaced by Christopher Bland, former chairman of BBC.

For another, the deal had to be discounted heavily to ensure investor participation. On May 10, BT revealed that investors could buy three new shares for every ten they currently held for £3 a share, compared with BT’s opening price that day of £5.69 and a closing price of £5.28. On the rights issue’s completion day—June 19th—the share price had fallen to £4.36. A year earlier, BT shares had traded for more than £10.

Hampton adds that the deal also required “one of the biggest investor road shows ever to take place”—amounting to 120 meetings across Europe and North America in three gruelling weeks for BT and its advisors, Cazenove and Merrill Lynch.

The hard work certainly paid off, with 89.5 percent of the new shares being snapped up by existing BT shareholders. The rest were auctioned off to other investors for prices ranging from £4 to £4.45. “That the rights issue was successful showed that there were a lot of people who thought BT was doing the right thing,” notes Mark Davies, a telecom analyst at WestLB.

Bankers add that the company also benefited from selling stakes in Japan Telecom, in J-Phone Communications (a Japanese mobile operator) and in Airtel of Spain for a combined £4.8 billion only a few days before the rights issue. “Those sales gave the rights issue a healthy push,” says one banker who asked not to be named. “It showed the company was serious about reducing its debt.”

Without the rights issue, BT’s deal-makers would have had many sleepless nights in 2001. Consider the company’s sale in May of Yell, its directories arm, to venture capitalists Apax Capital Partners and Hicks, Muse, Tate & Furst for £2 billion. Without the £5.9 billion raised from the rights issue, it’s likely that BT would have been “under a lot of pressure to sell assets at knockdown prices,” points out Hampton.

What’s more, BT could never have floated its mobile arm—called mmO2—in November without having made a cash call on its shareholders earlier in the year. In order for the carve-out to take place, the trustees of BT’s bonds, the Royal Debenture Corporation, demanded that the company beef up its equity before demerging mmO2.

It was tough at times, Hampton concedes, but he’s confident that BT is back on track. There’s no rest for Hampton though. The 48-year-old former investment banker from Lazards—known as a turnaround expert—announced in November that he’s leaving the company in 2002 and is looking for another ailing business to resuscitate. In today’s economic climate, it’s unlikely he’ll be out of work for long.

2. EURONEXT: TAKING STOCK

A three-way stock exchange merger, an IPO, and an ambitious acquisition. Who could ask from anything more from one deal?

If anyone wants to know how tricky initial public offerings can be just ask Serge Harry. As finance chief of Euronext, the E752 million (US$674) merger of the Paris, Amsterdam and Brussels stock exchanges, he’s seen a fair share of them. So when Euronext decided to launch its own IPO in what seemed to outside observers to be the worst possible conditions, Harry could have been forgiven for feeling a little nervous.

First of all, Euronext made its market debut only ten months after completing its three-way merger in September 2000. That meant Euronext’s executive team had to divide their time between preparing for the IPO and managing the post-merger integration. It also didn’t help matters that by the time Euronext launched its deal in July, Europe’s IPO market was grinding to a halt.

Harry, however, maintains that the decision to go for the IPO was never in doubt. “It’s true that at the beginning of the summer, market conditions weren’t the best, but when you have an opportunity to go public, you have to take it,” he says. Without it, Harry adds, Euronext’s acquisition plans—which include an accepted bid made in October for Liffe, the London-based derivatives exchange, and plans to merge with BVLP, the Portuguese stock exchange—would have been severely hampered.

Vote of Confidence

Thankfully for Euronext, investors shared Harry’s commitment. Bankers say the IPO—which was valued at E694 million and placed 25 percent of Euronext’s share capital—was 1.6 times oversubscribed, despite the unappealing market conditions.

Few argue, however, that completing the deal, which was priced between E24 and E27.50, was easy. For starters, notes JP Sacau, a managing director in equity capital markets at UBS Warburg, investors were initially sceptical about buying stock so soon after Euronext’s creation. After all, merging three companies from three countries—each with its own regulatory authority, traditions and IT systems—could be a recipe for disaster. “A lot of people were questioning the integration process,” Sacau says. “So it was important to get the company’s strategy across.”

Bankers add that it was also a challenge for Euronext to meet its own listing requirements—not least producing a three-year profit history. Ahead of the IPO, the company produced pro forma accounts based on French, Belgian and Dutch accounting principles and then converted them to International Accounting Standards.

As if that wasn’t enough, Euronext’s management team also had to explain the process to a diverse private shareholder base. Indeed, while most IPOs—such as privatisations or sales of family-controlled businesses—involve just a few shareholders releasing part of their stake in a company, Euronext had over 500 stakeholders. “Almost all the banks and brokers from the three countries had a stake in Euronext,” says Philippe Lacaille, a director in equity capital markets at BNP Paribas, a book-runner for the deal alongside ABN Amro and UBS Warburg. “We had to develop a step-by-step approach which respected shareholder equality and gave each of them the opportunity to sell stakes.”

Observers say, though, that completing the IPO when the equity market was rapidly deteriorating was the toughest aspect of all. French advertising group JC Decaux typified the state of the IPO market when it cut 20 percent off its IPO offer price so that it could complete its deal in late June—just days before Euronext launched its listing. “Most IPOs were either being downsized, priced at the bottom of their indicative ranges or simply cancelled,” says UBS Warburg’s Sacau. “In that context, it wasn’t the ideal time for an IPO from a company whose future is in part linked to the volume of IPOs in Europe.”

But now Euronext’s decision to press ahead with its IPO looks like a wise one. That’s because Euronext has begun using the proceeds of its IPO to fund acquisitions and to speed its integration. Most notably, industry watchers say that the E892 million all-cash bid for Liffe, which is still subject to regulatory approval, puts Euronext at the forefront of Europe’s exchange consolidation.

Better yet, acquiring Liffe will increase the derivatives proportion of Euronext’s revenue from 12 percent to 22 percent just as traditional equity trading volumes are falling. Experts note, however, that bidding for Liffe would have been tough without the proceeds from his IPO. “It wouldn’t have been impossible,” says one observer. “But it would have been more difficult and certainly more expensive.”

TELECOM ITALIA: ALL THE RIGHT NUMBERS

The telco launched Europe’s first securitization of telephone bill receivables and created a template for phone companies seeking low-cost funding.

When Telecom Italia appointed Maurizio Cappa as head of securitization in April 2000, the move caught people by surprise. Why did the E27 billion-in-revenues, Rome-based phone company need help with a debt-financing tool unheard of in the telecom sector?

After all, Europe’s leading telcos had met with few problems up until then raising unsecured bond and loan debt during the technology-led boom of the late 1990s. Indeed, Telecom Italia had refinanced billions of euros in short-term debt after being acquired by Olivetti in 1999.

Nonetheless, by the time the company launched a medium-term note programme backed by receivables from its 20 million domestic fixed-line phone customers in June, the decision to hire Cappa looked like a smart one.

That’s because the E700 million (US$627) deal, which was made up of three tranches of medium-term notes issued via a special-purpose company called TI Securitization Vehicle (TISV), allowed Telecom Italia to raise debt cheaply at a time when investors had turned against telecom issuers.

Copy-cats

Under the terms of the deal, the Baa1/BBB-rated telephone company launched three tranches of triple-A rated secured debt priced between 19 basis points and 34 basis points over Libor. By contrast, equivalent spreads on unsecured bonds for companies with credit ratings on a par with Telecom Italia were trading at 184 basis points. “We estimate that by issuing asset-backed securities rather than straight bonds, we saved E20 million, all costs included,” says Cappa.

The ground-breaking deal wasn’t just about one-off cost savings, though. Experts say that the securitization has broadened Telecom Italia’s investor base, and created a benchmark for corporate securitization in Italy. The deal—the first of its kind in the telecom sector—is also a template for cash-strapped telecom companies looking for a low-cost means of refinancing debt. Indeed, while only KPN of the Netherlands has so far followed Telecom Italia’s lead, Deutsche Telekom, France Télécom, Portugal Telecom and Austria Telekom are all believed to preparing copy-cat deals.

Bankers say the time it takes to prepare securitization deals explains the slow pace of replication. Andrea Perona, head of southern European securitization at BNP Paribas, notes that structuring asset-backed deals—which typically pool receivables such as credit card bills or student loans, and issue debt secured against them—can be a time-consuming process at the best of times. “Asset-backed securities are often the best alternative from a strategic standpoint and can be particularly cost effective, but they are not the quickest way of raising capital,” Perona says.

Mark Wilten, a director in asset securitization and principal finance at WestLB, adds that Telecom Italia deserves praise for launching its issue ahead of the game. “Before the markets turned, telecom firms had good access to unsecured debt and the bank loan markets, but this year they’ve had to be a lot more creative,” he says. “Telecom Italia showed a lot of foresight.”

Telecom Italia’s deal also set a precedent for Italy’s burgeoning securitization market which, despite being the third largest in the world behind the U.S. and the U.K., is dominated by financial institutions. Telecom Italia was the first Italian company from outside that sector to make use of the country’s April 1999 securitization law. “The law was designed primarily for banks securitising loans or other assets,” Cappa says. “So we had to work closely with the Bank of Italy to ensure our interpretation was right.”

WestLB’s Wilten, whose firm worked alongside BNP Paribas and Italian securitization boutique Finanziaria Internazionale, on Telecom Italia’s deal, adds investors also take longer to grasp the complexities of asset-backed deals. The deal “took some explaining and I can’t say 100 percent of investors liked it,” he says.

Nonetheless, Telecom Italia’s deal was 30 percent oversubscribed and helped Telecom Italia reach new investors. On the one hand, investors unwilling or unable to invest in Telecom Italia could buy into the triple-A rated securitized notes. On the other, pan-European demand enabled the firm to reach investors across the region. Spanish investors, in particular, were attracted to the deal—snapping up a third of the debt—while Italian investors got just 20 percent.

Despite the success of Telecom Italia’s debut securitization, Cappa says his work is far from finished. Indeed, even with a change of command at Telecom Italia in July—when tire giant Pirelli wrested control from Olivetti—Cappa says another E1.3 billion of telecom receivables-backed issuance is still on the cards, with the first portion perhaps as early as mid-2002. What’s more, he’s hoping to raise the debt on improved terms. “Now that there’s a benchmark in the market we think we will get even better prices.”

For complete coverage of fundings, financings, and capital-raisings in Europe, visitCFO Europe (www.cfoeurope.com).

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