If issuance volumes by German investment grade companies in 2004 has been disappointing, there has been plenty of compensation in the high yield arena. ?Germany has been the single most exciting market for high yield issuance and the fastest growing market in Europe in 2004,? says Matthew Cestar, of the European high yield capital markets team at Goldman Sachs in London. Specifically, Cestar says that by mid-October Germany had been the source of $6.8bn (equivalent) of new high yield issuance, or 34% of the European total.
The impressive charge has been led by companies in search of funding diversification. ?A clear trend we have seen among Mittelstand companies is that much more restrictive lending policies among banks are leading a growing number of companies to look for alternative funding sources,? says Ralf Brech, head of the corporate bond syndicate at HVB in Munich.
The German high yield bond market has been a very clear beneficiary of that process, especially given that most sub-investment grade companies will not generally be able to access the US private placement (USPP) market. ?Because the USPP market is generally closed to borrowers with an implied rating of BBB- or lower, companies rated below that will need to turn to the European high yield market to diversify away from bank lending,? says Neilinger at DrKW.
Jenoptik the breakthrough
Cestar traces the recent explosion in high yield activity back to a Eu150m seven year transaction led by Goldman Sachs and HVB late in 2003 for the Ba3/BB-/BB rated Jenoptik, which was heavily oversubscribed. ?The Jenoptik deal was a breakthrough transaction in the German corporate space because the company made a strategic decision to put a bond into its capital structure as a means of getting some long term funding for the business,? he says.
That, says Cestar, was a groundbreaker because before then most German companies that had tapped the high yield market had effectively had the decision thrust upon them by existing lenders that were looking to refinance loan facilities through the capital market.
Another decisive trend in 2003 that caught the attention of prospective borrowers in the high yield market, say bankers, was the success of transactions throughout Europe by well established corporate names that had been pushed into fallen angel territory.
The inclusion within that group of respected companies with obvious pedigree such as HeidelbergCement, as well as the likes of ABB and Vivendi, was enough to persuade a number of German corporates that borrowing on the basis of a sub-investment grade rating was not necessarily a badge of shame.
?That set off the recent boom in high yield issuance,? Cestar adds, ?and significantly the lion's share of that has been represented by corporate issuance rather than LBOs in terms of the number of financings.? Volumes, says Cestar, tell a different story, which reflects a handful of very large sponsor-driven transactions such as the recent deals for Kabel Deutschland which raised about $915m (equivalent) and Cognis ($700m equivalent).
Tui flies in
One of the most active users of the high yield market in 2004 has been Europe's largest travel group, Tui, the unrated company formerly known as Preussag. Its Eu400m five year FRN in June via RBS and WestLB was four times oversubscribed, allowing for the transaction to be increased from Eu250m and to be priced at 210bp over Euribor, well below the guidance range of between 215bp and 230bp over.
That followed an equally well received seven year transaction launched by Tui the previous month via Commerzbank, RBS and WestLB. Also four times oversubscribed, this deal was increased first from Eu350m to Eu500m and subsequently to Eu625m, with pricing set at the tight end of guidance.
Tui's May issue provided something of a novelty for the high yield bond market in its incorporation of a 75bp step-up for investors in the event that the company fails to secure a rating within 18 months.
The general consensus seems to be that the Tui step-up structure will be a one-off. As Brech points out, when the step-up formula has been applied in the past, most notably in the telecoms sector, it has been designed to offer bondholders compensation for any future deterioration in credit quality. ?In the Tui step-up, what's the benefit to the investor?? asks Brech. ?The credit quality of the company won't change just because it gets rated, nor is there a direct link to a specific rating. So I don't see why we should be likely to see that structure again.?
The Tui transactions have not been isolated illustrations of demand among yield-hungry investors for exposure to corporates a pick-up over the artificially tight spreads on offer to them in investment grade land. Among other deals, appetite for exposure to the telecoms sector has been satisfied to some degree with successful transactions for borrowers such as TeleColumbus and Kabel Deutschland (KDG), which in June launched its Eu750m 10 year non-call five high yielder via Deutsche Bank, Citigroup, Goldman Sachs and Morgan Stanley.
Away from the telecoms sector, diversification among German high yield issuers has been provided by borrowers from several different industries ranging from auto parts to bathroom fittings. The high yield market in 2004 has also offered investors exposure to an unusual industry via the modestly-sized but successful deal led by Citigroup in July for the small arms maker, Heckler & Koch. That seven year transaction, priced at 560bp over Bunds, was increased from Eu115m to Eu120m and priced at the tight end of guidance with a 9.25% coupon.
Some of the more spectacularly oversubscribed transactions, meanwhile, have included a Eu335m 10 year deal for the bathroom fittings manufacturer, Grohe, led by Citigroup, CSFB and Deutsche Bank and five times oversubscribed, and the Eu150m 10 year bond for auto parts company ATU via Morgan Stanley and HVB which generated orders of Eu600m.
That strength of demand has also allowed highly leveraged companies to tap the market at outstandingly good terms. ?Grohe is a company that is leveraged by more than six times Ebitda but was still able to issue at 8.625% which represented very good execution for the borrower,? says Paul Simpkin, managing director of European high yield at Citigroup.
The existence of investor demand of that magnitude testifies to a seismic shift in the structure of the universe of institutions in Europe that are buying high yield bonds. ?What we've seen across the whole European high yield market over the last two years is that it has become much better diversified in terms of geography, types of business and ratings categories,? says Cestar at Goldman Sachs. ?That diversification has attracted a much broader range of investors, so we are now seeing demand from insurance companies, pension funds and some retail money as well as the dedicated high yield funds.?