A flexible tool for M&A

  • 28 Mar 2006
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When Nippon Sheet Glass convinced the board of UK glass maker Pilkington to agree its £2.2bn takeover bid, a key factor was certainty of financing. And the centrepiece of NSG's funding package for the deal was Japan's largest ever moving strike convertible bond. The ¥110bn transaction gave NSG three key advantages: flexibility, certainty and cost. It is debatable whether any other financing technique would have served it as well.

Nippon Sheet Glass Co's bold acquisition of the UK's famous glass maker Pilkington for £2.2bn (¥438bn), announced in late February, was a milestone for corporate Japan.

Pilkington is one of the world's oldest and most prestigious glass makers, and one of Britain's best known blue chip companies. Nippon Sheet Glass is Japan's second largest sheet glass maker, but is smaller than Pilkington and less international — only 15% of its sales are outside Japan. In mid-March Pilkington was valued at about £2.3bn and NSG at $2.3bn.

NSG tried twice to buy Pilkington in 2005 and was rejected each time, partly because the UK firm saw its financing arrangements as unsatisfactory.

This time, Pilkington's board agreed to the acquisition at a higher price of 165p a share, making it a friendly takeover that will take Pilkington out of the London stock market. If the deal is cleared by competition authorities in various countries, it will close by late June this year, creating a global leader in the flat glass industry with, Nippon Sheet Glass estimates, the largest market share in the world and about $6.6bn of sales.

NSG hopes the deal's efficiency and competitiveness benefits will "significantly enhance shareholder value". It will allow it to enter the European market and increase its strength in China.

Pilkington operates in 24 countries spanning Europe, North America, South America and China. NSG first bought a 10% stake in 2000 and increased that to 20% in 2001, when Pilkington became an affiliated company under equity method accounting.

The merger will, according to NSG, make the enlarged company truly global, with 41% of sales in Europe, 31% in Japan, 14% in North America, 4% in Asia excluding Japan and 10% in other areas.

But besides creating a world-leading glass company, the deal was also a landmark for the financial markets, since NSG chose to raise a large chunk of the financing with a private moving strike convertible bond (MSCB), arranged by Daiwa Securities SMBC and UBS.

The ¥110bn deal, completed in mid-March, was the largest MSCB recorded, and gave a vivid demonstration of the technique's usefulness for financing acquisitions.

NSG is paying £1.8bn (¥359bn) for the roughly 80% of Pilkington's shares it did not already own, but it estimated that the total transaction funds required would be £3.02bn (¥616bn), including refinancing Pilkington's existing debts and other transaction costs.

NSG's estimated breakdown of the funding comprised ¥89bn from cash in hand and sale of marketable securities, ¥318bn of new bank loans in the UK and ¥45bn of new loans in Japan. The privately underwritten MSCB adds another ¥110bn and other funds ¥54bn to make a total of ¥616bn.

Crucial flexibility

The ¥110bn moving strike convertible, privately underwritten 70% by Daiwa Securities SMBC and 30% by UBS, has far-reaching implications for M&A financing in Japan and for the private equity securities market.

It will make other Japanese companies acquiring businesses think twice about going the public route to raise equity.

NSG said it was using this funding technique because it offered a contingent funding mechanism, flexibility and low cost.

Among many advantages for NSG, perhaps the most important was that the deal allowed it to raise equity contingent on completion of the acquisition. The two banks have provided the money up front and committed to buy shares, but if for some reason the acquisition does not go through, the deal can be cancelled.

NSG has agreed with the underwriters that they will not convert the bonds (technically, exercise their stock acquisition rights) unless the Pilkington acquisition becomes effective, and that if it does not proceed, NSG will redeem the bonds.

This would not be possible with a straight equity issue or public market convertible bond.

Even though the Pilkington deal was recommended by both boards of directors, NSG knows well enough that mergers and acquisitions often do not go as smoothly as buyer or seller would like, especially when they occur across borders, timezones and language barriers, and when the target is a listed company.

Add to that competition review in many countries, the results of which are never easy to predict, and NSG's decision to raise contingent equity-linked funding appears natural.

Certainty of funding

However, although the deal can be called off if NSG no longer needs the fresh equity, the transaction gives it greater certainty of obtaining the equity than it could have in the public market.

NSG also said the terms and conditions of the stock acquisition rights (shinkabu yoyakuken) were structured to promote smooth conversion and thereby strengthen NSG's financial structure, at the same time as taking account of dilutive effects on earnings per share. The company calculated the dilution of this issue at 42.6%, based on the share price at the date of issue.

A standard convertible bond, publicly issued either in Japan or in the offshore market, would be convertible at a premium above the share price at the time of issue.

That might sound more enticing to an issuer than a private MSCB with stock acquisition rights at a discount to the underlying market share price.

However, a public issue to finance an acquisition that is subject to contingencies and with a financial impact that will take time for analysts and investors to assess, might well have pushed down the stock price, helped no doubt by some of the buyers putting in delta hedges.

Indeed, NSG's share price had already fallen sharply from a 52 week high of ¥600 on January 16 to ¥465 on February 20, though the market reacted kindly when news of the acquisition broke, marking NSG up 5.2% to close at ¥509 on February 27.

Moreover, a public CB would have no surety of conversion into pure equity and certainly not as early as possible. That might mean NSG's balance sheet being saddled with debt for several years (this issue has a three year maturity), or the bond might never be converted.

The last convertible bond issue NSG had sold was in May 2004, when it raised ¥23bn of bonds due 2011 with a conversion price of ¥542. The share price has since exceeded that figure and fallen back below it, so any investors that have not converted their bonds will not do so until the share price again rises beyond the conversion price. Until then, the unconverted bonds will remain as debt.

And NSG was keen to avoid leveraging up its balance sheet too much. The Japanese newspapers were quick to highlight concerns that NSG's financial health would be harmed by the deal, especially with an estimated ¥220bn of goodwill to amortise.

Japan's Rating & Investment Information said it was considering downgrading Nippon Sheet Glass's BBB+ rating. Moody's Investors Service has also indicated it may cut NSG's Baa2 rating.

In contrast to a public CB, because the MSCB converts at a discount to the market share price, the investment banks are incentivised to convert at any time, and will have the choice of doing so whenever it suits them.

Even if NSG had thought seriously about the far less flexible alternative of issuing a public CB, the reality is that the domestic and global CB markets have been quiet for over a year, thanks to low equity volatility and hence a shortage of issues.

It would be a brave issuer that would try to raise such a big issue, equating to $940m — indeed, it is unlikely that the Japanese domestic CB market could absorb a deal of that size.

By going private, NSG was able to raise a large amount of funds with the minimum of fuss.

Designed to suit the occasion

The deal was possible because Daiwa SMBC and UBS could, it can fairly be assumed, rapidly and behind closed doors make their own assessment of the financial merits of the Pilkington acquisition. They could therefore quickly agree to underwrite the issue, knowing that their exposure to NSG's credit would be eliminated as soon as they chose to convert the bonds into stock.

It could be argued that by using the MSCB, Nippon Sheet Glass used the most appropriate financing mechanism for its situation. It obtained contingent equity funding, avoiding the risk of diluting its shares unnecessarily if the merger breaks down.

It ensured that its balance sheet would soon be deleveraged with a fresh and very large infusion of equity.

And it could be seen as having done as much as it reasonably could to protect its stock price. The MSCB may turn out to be more dilutive than other forms of equity raising, but if the share price fell, a public CB or equity issue would also become more expensive.

And the two banks have a keen incentive not to dump too much stock into the market at once, since their profit will come from the margin between the 9% discount at which they will acquire the shares and the discount to the market price at which they are able to sell them.

NSG also has a failsafe mechanism to prevent drastic dilution if its share price falls by more than 50%: it has a right to redeem the bonds at any time before the maturity date.

NSG explained that due to the uncertainties surrounding the acquisition — for example, competition issues — the cap and floor conversion prices will be decided based on the average share price for the five consecutive trading days leading up to May 8, 2006.

Nippon Sheet Glass is one of Japan's most expansionary and boldest companies. Taking on such a large company relative to its own balance sheet and market valuation is a dramatic and exciting move that allowed it to leapfrog the global market share of Japan's number one glass maker, Asahi Glass.

The role of the MSCB and of Daiwa SMBC and UBS in providing the underlying assurance on the equity financing for the transaction cannot be underestimated. The MSCB has come of age. 

'Convertible-bond-type bonds'

What exactly did NSG arrange with Daiwa SMBC and UBS?

In Japan there is no legal concept of convertible bonds. Instead, bonds are issued with stock acquisition rights embedded.

Accordingly, when NSG's board of directors met on February 27, it agreed to issue what were termed 'unsecured convertible-bond-type bonds with stock acquisition rights', or in Japanese, tenkanshasaigata shinkabu yoyakuken-tsuki shasai.

The bonds were to be issued by way of third party allocation, which allows for stock to be placed away from existing shareholders, which in Japan do not have pre-emptive rights to be offered any new share issue.

On March 15, Daiwa SMBC bought ¥77bn of the bonds and UBS's London branch ¥33bn. These will give them the right to acquire shares at a 9% discount to the market price. The conversion price resets twice monthly to keep it aligned to the share price. The lower the share price goes, the more shares they will get for their money.

Once the banks have converted some of the bonds into shares, they are free to sell them. The banks' decision on how much of the deal to convert, and when, will depend on the liquidity of NSG's shares and the broader momentum of the Tokyo Stock Exchange.

As is standard in virtually all MSCBs, the underwriters agreed with NSG not to transfer the bonds or the stock acquisition rights to third parties at any time during their three year lifetime.

That protects NSG from the bonds or stock purchase rights being transferred to, for example, hedge funds or other entities that might have less inclination to protect its share price from any short term adverse volatility.

Moreover, both underwriters also agreed, again in fairly standard MSCB wording, that "except for sales of NSG stock which fall within the total number of shares acquired through the exercise of stock acquisition rights and which are of the same nature as that stock, they will not borrow NSG stock for the purpose of selling short in relation to the purchase of the bonds".

And the deal will be cheap — the bonds are zero coupon and involve no issue-related commission. The investment banks will make their money purely from the conversion discount, which will enable them to buy stock below market price. They can then sell it at a narrower discount to the market price, making a profit. 

Nippon Sheet Glass MSCB
Terms and conditions

: Nippon Sheet Glass Company, Limited 1st Unsecured Convertible-Bond-Type Bonds (shasai) With Stock Acquisition Rights (shinkabu yoyakuken)

Total issue size: ¥110bn

Issue price: ¥100 per ¥100 par value

Denomination: ¥500m

Interest rate: zero coupon

Redemption date: 13 March 2009

Issue price of stock acquisition right: nil consideration

Payment date and issue date: 15 March 2006

Type of offering: By way of allotment to a third party (dai sansha wariate), ¥77bn will be allotted to Daiwa Securities SMBC Co Ltd and ¥33bn will be allotted to UBS AG, London Branch.

Matters relating to the stock acquisition rights: The underlying shares are ordinary Nippon Sheet Glass shares and the number of shares (either newly issued or treasury stock) following exercise of the stock acquisition rights shall be determined by reference to the issue price and conversion price. The stock acquisition rights are attached to the bonds and cannot be sold separately.

Period for exercise of the stock acquisition rights: at any time from 16 March 2006 to 12 March 2009

Shusei-adjustment of the conversion price: After 8 May 2006, the conversion price shall be adjusted from the trading day following the 1st and 3rd Friday of each month (the 'Reset Date') to equal 91% of the average of the daily volume-weighted average price of the ordinary shares of NSG for ordinary market transactions on the Tokyo Stock Exchange for the three consecutive trading days ending on and including the Reset Date.

Floor and cap conversion price: If the adjusted conversion price falls short of 50% of the average trading price for the five trading days ending 8 May 2006 on the Tokyo Stock Exchange the floor conversion price shall be the adjusted conversion price.

If the adjusted conversion price exceeds 150% of the five day average trading price to 8 May 2006 then the cap conversion price shall be the adjusted conversion price.

Redemption: NSG can at any time redeem before maturity all of the then outstanding bonds (partial redemption is prohibited) at prices between ¥100.50 per ¥100 par value from 16 March 2006 to 15 June 2006 up to ¥101.10 per ¥100 par value for the period from 16 August 2006 and so on plus ¥0.20 per month thereafter.

Put: If the NSG closing price on the Tokyo Stock Exchange drops below the floor conversion price for the 10 consecutive trading days commencing at any time on or after 15 June 2006, the bondholders can put the bonds back to NSG at 100.00.

Call: NSG may, at any time on or after the day following the issue date, purchase and cancel the convertible bonds and also waive the corresponding stock acquisition of those convertible bonds.

Form of bond certificate: Bearer form. Under Clause 4, Article 341-2 of the Commercial Code (Shou Hou), bonds and stock acquisition rights may not be transferred separately.

Credit ratings: None obtained for the issue.

Filing: Each of the provisions above is subject to the filing under the Securities and Exchange Law (Shouken Torihiki Hou) becoming effective. 

  • 28 Mar 2006

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
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4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

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Rank Lead Manager Amount $m No of issues Share %
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4 HSBC 22,935.49 112 5.38%
5 ING 18,645.88 118 4.37%

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5 UBS 8,763.73 42 6.23%