Once considered a pioneer in the hybrid bond market, Dong is facing a future that will involve fewer of the eye-catching trades than it sold in the past. Standard & Poor’s changed its criteria for hybrid bonds’ equity profile in April — taking Dong by surprise, particularly as there was no grandfathering of existing structures.
Dong’s outstanding €700m hybrid went from being 100% equity to 0% in S&P’s view. That meant it was paying a nearly 8% coupon on what was now effectively senior debt. A new senior deal would have paid a coupon of around 3%, according to the issuer.
It plans to avoid such atypical trades in the future.
“There were only about 10 companies with high equity structures, which may have been seen as expendable from S&P’s perspective,” says Peter Løvstad, senior lead funding manager at Dong in Fredericia, Denmark.
“Changing the 50% structure — where the majority of the issues are — would alienate the whole utility sector. So the lesson for us is that we are not big enough to deviate from the market standard.”
But the situation could have been much worse. After finding it could not amend the bond’s terms and conditions to still receive 100% equity treatment, the company entered into an exchange for a new issue with a 50% equity structure in June.
Dong’s exchange was controversial because it offered to buy the old hybrid back at 104, despite it trading at about 110 before the exchange was announced.
The 104 level was seen as a compromise, as the bond documentation allowed Dong to call the security at 101 if one of the rating agencies withdrew its equity credit for the transaction.
There was a worry at the time that the exchange terms could alienate investors. But only €90m of the old hybrid remains outstanding and Dong’s reputation has not been sullied, according to bankers.
“There were no accounts that told us they would not invest in this name in the future after the exchange offering went out,” says a senior corporate syndication banker in London.
“Dong’s credit story is rather good and the exchange has been a great success.”
Further proof that investors would not shun the credit came less than two weeks later, when it sold another €500m 50% equity hybrid.
“There was a lot of interest, despite somewhat turbulent markets,” says Kristian Borbos, lead investor relations manager at Dong.
“As the debt markets developed favourably in the following two weeks we decided to capitalise on that with a second deal. There is a lot of preparation involved with a hybrid compared to a senior bond. Had we waited another year for the second deal, there would be a need for a new prospectus and other factors. The window for issuing hybrids is not always open.”
Equity up next
Hybrids with equity treatment are a useful tool for government owned issuers like Dong, which must clear any attempt to raise capital with their sovereign parent.
But the company has been given permission to raise Dkr6bn ($1.1bn) to Dkr8bn of equity this year, which could come from both a private placement and existing shareholders.
That proposition may be more attractive to investors after an improved first half performance in 2013 compared to last year.
“2012 was a quite a difficult year for Dong, but so far 2013 has been better and we have revised our earnings forecast upwards,” says Borbos.
“We launched a financial action plan due to the poor performance last year, we have our equity plans, a cost reduction programme and divestments that have come through this year — worth around Dkr9bn. We feel reasonably comfortable that we are on track with improving the financial performance of the company, which — as with all utility firms — has been under pressure lately.”
Bankers agree that Dong should have no problem raising equity once its finances are back on track. “They have been under pressure but it’s one of the best utilities in the northern part of Europe,” says a senior corporate syndication banker in London.
“They have some constraints and have limits on how to deal with the shortfall in their capital but again, when we look to the level of appetite that we have seen on this name it’s quite clear that their reputation is intact.”
Further in the future, the Danish state intends to launch an initial public offering, which would see its 81% holding in Dong fall to at least 51%.
But government officials have said this is unlikely to happen in the short term.