Nomura made a breakthrough in the global equity capital markets in January, when it sold a Eu1.1bn bond for KfW, exchangeable into Deutsche Post stock, to Japanese retail investors. The Uridashi market deal is a case study in creativity and will be a useful alternative for foreign companies and institutions wanting to sell stakes in blue chip companies.
The idea that a top tier, triple-A OECD government institution might sell exchangeable bonds to Japanese individuals was new to KfW when Nomura first broached the concept early in 2004. But less than a year later Nomura had turned imagination into reality, with a blowout transaction, which started at just Eu500m and closed 120% larger.
The deal was the first ever Uridashi equity-linked bond. Uridashi bonds are foreign currency bonds issued by non-Japanese borrowers, but registered in Japan and sold to Japanese retail investors.
Nomura had enjoyed a long and successful association with KfW in the Japanese debt markets, and parlayed this relationship into an exchangeable issue targeted solely at the Japanese retail market.
The world's top tier credits, including KfW, have been regular issuers in the Uridashi market in recent years. But until this deal they have sold plain vanilla fixed income products. Japanese individuals are hungry for spread but cautious on foreign credit, so triple-A government or multilateral agency names are perfect for them.
"Not only did it tap into a new investor base for KfW's privatisation team, but it would reach long-only retail equity investors," says Salim Salam, director, equity and equity-linked syndicate at Nomura International in London.
The low 12% premium combined with this type of investor also meant that KfW would be assured of a high probability of conversion.
"For KfW's overriding privatisation and monetisation objective, that was absolutely core to our success in obtaining the mandate," says Salam.
Privatisation, not funding, the goal
Christian Funke, first vice president at KfW in Frankfurt, explains that funding was not the main objective. "If we want the lowest cost of funds, our debt and treasury team would scour the world's markets, as they do constantly," he says. "Our mission is privatisation and to achieve that in an orderly and cost-effective manner we need access to as many different monetisation sources as possible."
"The concept [for the deal] was immediately clear and attractive to us," says Funke. "However, we are a state owned bank and have a responsibility to the state and the German people and therefore we took time to do our research before we gave the project the green light."
The five year bonds were offered with a fixed 0.5% coupon, the lowest ever offered on a KfW exchangeable, and were marketed with a conversion premium of 11%-17%. That was set at 12%, but only after the stock had risen around 6% during the two week sale process.
The issue was priced at a tight discount to the existing KfW into Deutsche Post Eu1.15bn issue (due January 2007). Salam says: "Institutions in the Euromarket would have demanded a far larger discount to the 2007 KfW notes in the then prevailing markets, which would have negatively hit the outstanding bond."
Nomura initially offered Eu500m of bonds with 25.4m underlying shares, equivalent to 2.3% of Deutsche Post's issued share capital. But that was increased to Eu1.1bn after orders came in for Eu1.2bn of bonds with an average order size of more than Eu33,000.
As KfW owned 48.8% of Deutsche Post at the time the deal launched — and as there was no regulatory constraint on the deal's size — both issuer and arranger were delighted to increase the deal size while maintaining the enticing terms for KfW.
In a standard EuroCB, even if as in this case the shares were secondary stock, the market price would normally be hit as many of the funds put their delta hedge strategies in place.
In this case, the stock went up almost 6% during the two week marketing period. Moreover, the stock continued to appreciate after pricing — within a month of pricing the stock was up a further 3.5% and within three months it had gone over the conversion price.
Funke says: "The Euromarket would not have been receptive to a low coupon, low premium deal and the investors would have immediately sought to hedge their exposures — so implying pressure on the underlying stock. Moreover, the size of this transaction was larger than the Euromarkets might have coped with and the institutions would have demanded a larger new issue discount against the implied volatility at which our outstanding KfW/DP issue then traded."
The choice of KfW, a regular presence in the plain vanilla Uridashi bond market, and the Deutsche Post shares as the equity was inspired.
Because of the sheer size and importance of Japan Post, the Japanese appreciate the importance of Deutsche Post. Japanese investors were eager participants in its Eu6.7bn IPO in 2000. Such was the popularity of the offering that all 2,800 Nomura bank branch sales representatives were used to sell the issue. This drew orders from about 32,000 investors, out of a pool of 200,000 wealthy clients the bank had picked out for the deal.
Nomura is now hopeful that it will be able to convince other would-be issuers of the merits of such a transaction. The bank will clearly be helped by the big vote of confidence KfW gave the transaction.
"We were delighted with the result, as the deal was better in almost every facet than we might have been able to achieve in any other market at that time," Funke concludes. "All in all, this was a rare and special deal."