As anticipated, the first quarter of 2023 offered a marked increase in new issuance in the convertibles market, which presented itself across many sectors with a tilt towards Investment Grade issuers.
The majority of the Convertible bonds (CBs) coming to market in 2023 have a feature that has been absent for many years: a meaningful coupon. Our review of 2023 convertible bond issuance shows that the (non-weighted) average coupon for a new convertible deal in USD was 3.56%. In 2021, that average coupon was only 1.27%. By comparison, that same analysis for all USD corporate bonds raised in 2023 shows that the average coupon paid was 5.28%, with an average of 3.4% for 2021.
Given the wide variety of the issuers and deals coming to our market, we have found it useful to produce ad-hoc summaries relating to interesting new issues, which we aim to publish on the day the new deals are announced – our CB New Issue Radar.
Below are some examples from the first quarter, however, please note that commenting on the characteristics of the respective issues does not constitute a recommendation or infer that we participated in every new deal.
SPIE SA 10th January 2023
With the pre-conditions set for a potentially attractive environment for issuers in 2023, the anticipated flood of new issuance has begun. After one of the strongest ever starts for IG fixed income primary issuance last week, the convertibles market has already been graced with a number of new deals this week.
SPIE SA – a newcomer to the convertibles market – announced a €400m offering this morning, with a 5-year maturity, a coupon range of 2-2.5%, a high bond floor and a conversion premium of between 32.5% and 37.5%. In addition, the bond indenture provides for a sustainability-linked premium payment if the company doesn’t reach its target ESG-related goals by December 2025. Using a 175bps credit assumption and input volatility of 24%, models suggest the theoretical (or “fair”) value of the bond is just above par and with a delta of between 43 to 45%. The company, which has a strong French shareholder base, was unsurprisingly brought by a consortium of largely French banks, including BNP, Société Générale and Crédit Agricole.
SPIE SA is the European independent pure-player leader in multi-technical services in the energy and communications sectors. The company performs and provides engineering services, mainly for energy infrastructure. The company has a good record on ESG: purchase of energy from suppliers that are low carbon or that are achieving reduction targets, female representation in key management roles and the company’s revenues aligned to EU taxonomy on climate mitigation.
From a credit perspective, the company has 2 outstanding straight bonds of €600m each, maturing in 2024 and 2026 respectively – has approximately 40% Debt/EV in total – and is BB rated by S&P. On the equity side, the company has a €4bn market cap and trades on a P/E multiple in the low 20’s.
Given that SPIE SA represents a sector to which we lack exposure in the convertibles market, the green focus (leader in energy transition and digitalisation) and with the sustainability linked premium feature, we wouldn’t be surprised to possibly see this convertible bond trading richer in the secondary market. Comparable issuers – albeit Investment Grade – Iberdrola and Schneider Electric are now both trading at implied volatility above where they issued in the primary market.
Rheinmetall Defence 1st February 2023
“The LUNA NG unmanned aircraft is the latest element in the LUNA system for real-time airborne surveillance, detection and tracking. With its ultra-light but highly stable fuselage structure made of CFRP (carbon fibre reinforced plastic), it offers a flight time of over 12 hours – and with its data link range of over 100km, it achieves a spatial coverage of more than 30,000 km2.”
LUNA is one of the latest offerings from Rheinmetall Defence, the German military and auto equipment manufacturer, best known for manufacturing the Leopard 2 tank and its 120mm mounted gun. Rheinmetall is the latest European Investment Grade-rated issuer to turn to the convertible bond markets, seeking €1bn. This morning the company announced the capital raise, in the form of two €500m convertible notes, of 5 and 7-year maturity. The deal, brought to markets by BofA Securities, BNP Paribas and Barclays, states part of the use of proceeds as financing a significant share of the intended acquisition of Expal Systems SA, announced by Rheinmetall in November 2022.
As a team, we are clear on where we draw the line on what is acceptable and what is not when it comes to armaments and the defence industry more broadly. There is an important distinction we would make between defensive weapons and surveillance systems that are manufactured by well-governed, EU-domiciled companies that supply to a regulated customer base, versus malicious weapon systems such as anti-personnel mines and cluster munitions. Rheinmettal’s vast product suite ranges from armoured vehicles, Unmanned Aerial Vehicles/Systems (UAV/S) and ammunition, to electro-optics, propulsion systems and actuators for vehicles.
„We can produce 240,000 rounds of tank ammunition (120mm) per year, which is more than the entire world needs,“ CEO Armin Papperger has been quoted as saying in an interview with Reuters. The War in Ukraine has sadly highlighted just the reliance that many nations have on adequate defence resources and demand for these munitions has soared since the invasion in February last year, not only due to their use on the battlefield but also as Western militaries backfill their own stocks, preparing for what they perceive as a heightened threat from Russia.
The bond’s term sheet proposed a 5-year maturity [series A] instrument with a coupon of between 1.625 and 2.125% and a conversion premium of 40-45% and; a longer-dated 7 year maturity [series B] instrument with a coupon of between 2 and 2.5% with the same conversion premium. As is the case with some European convertibles, the bond’s terms do not offer full dividend protection, meaning investors have to account for lost dividends paid out during the life of the bond. Our analysis of the two bonds, using 120bps (2028 maturity) and 150bps (2030 maturity) credit spread assumptions, respectively, and a fair vol of 35%, put the theoretical (or ‘fair’) value of the bonds at 103% and 105% of par, delta at 47% and 53%, and with bond floors of 90% and 87% of par (all at mid-pricing).
FEMSA 23rd February 2023
Flexibility is a key feature of convertible bonds and means that new deals can be positive for both issuers and investors, as opposed to a zero-sum game. We see that dynamic at play in a new EUR 500 million, 3-year maturity exchangeable bond launched after the European market close on 16 February by FEMSA—Fomento Economico Mexicano SAB de CV, the major Coca-Cola bottler in Mexico—that converts into shares of Heineken Holding NV (HEIO).
Exchangeable bonds can be a highly useful tool for large holders of listed stocks to monetize these holdings. In the case of FEMSA, which took a stake in the Dutch brewer more than 10 years ago, the company has just concluded a strategic review with an outcome to divest its Heineken holding. Using a convertible structure where an option is embedded into bond represents (in part) a forward sale of its Heineken stock that holding that can be delivered upon conversion, but at a premium to today’s price, and without selling that stock directly into the market. In return, investors that subscribe to the deal receive an option on a well-known blue-chip consumer stock that is new to the convertible bond market and can do so in the form of an expected investment-grade rated instrument with decent coupon and reasonable equity sensitivity.
This new exchangeable bond was brought to market by three banks: Bank of America, Goldman Sachs, and Morgan Stanley. It can convert into shares of Heineken Holding (HEIO), which holds 50.01% of the shares of Heineken NA (HEIA). FEMSA’s strategic holding in Heineken was structured via shares of Heineken Holding, where the Heineken family and other holders control just over 50% of those shares. The coupon range was set between 2.375% and 2.875%, with a conversion premium range between 25-30% placed off a concurrent equity offering of EUR 3 billion in shares of Heineken Holding NV (HEIO) and Heineken NV (HEIA). (On the morning of 17 February, the final terms of the deal were set at 2.625% and 27.5% premium, so at the middle of the marketed range.) Heineken made a commitment to purchase shares in the equity offering of both lines of stock, which should support the overall stock placement and minimize the discount required to place these shares. An interesting aspect of the stock placement for the exchangeable is that there is an allocation for delta-hedged holders to offset the short stock position they would usually set up as part of their strategy, further minimizing impact to Heineken Holding stock. These exchangeable bonds will carry some dividend protection, meaning that dividends paid above a threshold amount (EUR 1.73, or a yield of roughly 2%) will be compensated by an adjustment to the conversion ratio so that exchangeable holders will receive additional stock.
We felt that the assumptions from the lead banks (credit spread of 80 basis points, stock borrow cost of 40 basis points, and volatility of 22%) appeared reasonable, and that the exchangeable bond would likely be well received by all players in the convertible bond market. Long-only investors can now get exposure to Heineken, which is a high-quality name in a sector where there is currently no exposure in our market. (We have seen brewers issue convertible bonds in the past, including Asahi and MolsonCoors, as well as a smaller exchangeable issued by Spanish brewer Damm into shares of Ebro Foods.) The output delta when using the leads’ assumptions comes out in the mid-30s range, and that equity sensitivity is geared more towards the community of long-only, directional holders. Some brokers not involved in the underwriting have made their own assumptions to arrive at a fair value range of just below par to par. Still, we think the deal can still work for delta-hedged, relative value investors. The presence of a delta placement should help avoid spikes in the stock borrow cost (a higher cost to short stock reduces the potential return from the hedged position) and many of these delta-hedged investors may subscribe if they imagine these bonds will be in high demand by long-only investors, which could cause the price of the exchangeable bonds to richen. In sum, something for everyone.
Selling this exchangeable bond along with a stock placement allows FEMSA to monetise about half of its position in Heineken, and the speed and flexibility of this total transaction is clearly helpful to the issuer. There may remain an overhang on the Heineken stock price if FEMSA continues to sell shares into the market. That said, the presence of a meaningful coupon for investment grade credit reduces the possibility of a hangover to holders of the exchangeable bond, as does a conversion premium that incorporates the discount incorporated in the stock placement price.
 Bloomberg as of 13th April 2023
 Rheinmetall AG
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