MARKETWATCH Deal Analysis

BAe’s record-breaking sterling Eurobond issue British Aerospace recently launched the largest ever sterling-denominated Eurobond issue by a UK corporate. Gavin Brake of Goldman Sachs reviews the transaction.

t 7.30am on 22 June 1999 British at a price of 205p per share in March Aerospace plc (BAe) surprised the BAe achieved a 1996 to 908p on the day prior to Amarket by launching a £686m launch of the exchangeable offering. bond exchangeable into approximately precedent-setting In addition, conditions in June 1999 5% of the issued and outstanding ordi- sterling offering in in the convertible and fixed-income nary shares of Orange plc (Orange). To markets were favourable for new issues, date, this transaction represents the terms of size and with a notable lack of both high-quality largest ever sterling-denominated pricing, executed sterling denominated fixed-income and Eurobond issue by a UK corporate. convertible debt. This transaction, launched and priced on an accelerated However, there were also concerns at in one day with only a small impact on timetable and that time about equity markets peaking, the underlying share price of Orange, fixed-income spreads potentially widen- offered BAe the double benefit of very placed in the ing and forthcoming heavy debt and low cash-cost, sterling-denominated market with little equity issuance anticipated for the peri- debt, combined with the opportunity to od from early September until mid- sell its holding of Orange shares at a pressure on the November 1999. Based on this under- meaningful premium to the share price underlying share standing, BAe decided to launch, price at launch. and close the transaction on an acceler- price of Orange ated basis prior to the summer. Background on the holding BAe’s association with the mobile tele- Rationale and products considered phone business in the UK dates back to in March 1998, leaving BAe with a A number of different financing alterna- early 1991 when a consortium led by residual holding of 59.96m shares or tives were open to BAe. The clear expec- the company (under the name Microtel 5.0% of Orange. tation of the equity market was a block Communications Ltd) was first awarded trade of the remaining shares, similar to a licence by the DTI to operate a per- Market conditions the March 1998 transaction. In addi- sonal communications cellular tele- From an equity market perspective, the tion, given the size of the remaining phone network (PCN). In July 1991 highly successful performance of stake relative to the daily trading liquid- Hutchinson Telecom, part of the Hong Orange as a business, combined with ity in Orange shares, BAe would also Kong-based trading group Hutchinson positive market sentiment towards the have been able to put in place a value- Whampoa, acquired Microtel telecom sector, had together driven up protecting, private, derivative transac- Communications Ltd from BAe in the share price of Orange from the IPO tion, such as an equity collar. exchange for a 30% stake in the result- For BAe, however, the exchangeable ing company. The business was subse- bond disposal strategy best matched its quently renamed Orange Personal corporate objectives and offered a Communications Services Ltd. BAe fur- number of unique advantages: ther increased its holding in the business to 31.6% (and in Hutchinson Whampoa ● first, the exchangeable offered the to 68.4%) in July 1995 when Barclays opportunity to sell the underlying Bank plc sold its 5% equity interest to the shares at a premium to the Orange two principal shareholders. share price at launch; In March 1996, Orange underwent ● second, the very low, fixed-rate an initial public offering (IPO) and list- coupon on the bond offered BAe the ing on the London Stock Exchange and opportunity to lock in highly attrac- NASDAQ. Following the completion of tive, sterling- term funding; and this offering, BAe’s shareholding stood ● third, the exchangeable bond offered at 21.1%. This equity crossholding was proceeds today for BAe, but without then further reduced in a block trade crystallising a capital gain for tax of an additional 16.1% of the company Gavin Brake purposes until investors exchange the

14 The Treasurer – October 1999 MARKETWATCH Deal Analysis

bonds. This TABLE 1 Large sterling denominated corporate bonds and will most convertible/exchangeable bonds 1990–1999 likely occur only at Announced Issuer Size Offering Type Maturity maturity of 22 June 1999 British Aerospace Plc/Orange Plc £686m Exchangeable 21 July 2006 the bonds, 28 April 1999 British Telecommunications Plc £600m Fixed rate 7 December 2028 or if BAe 25 August 1993 British Telecommunications Plc £500m Fixed rate 5 September 2003 exercises its 16 April 1991 Hanson Plc £500m Convertible 31 January 2006 ability to call 22 April 1992 Hanson Plc £500m Fixed rate 20 October 1997 the bonds 12 May 1995 Glaxo Welcome Plc £500m Fixed rate 1 December 2005 for early 9 January 1998 National Grid Group Plc £460m Convertible 17 February 2008 redemption (see below). Note: all sterling deals were issued by public and private corporates and utilities, excluding banks, other financial institutions and government/sovereign issues. Source: Euromoney Bondware From the perspective of Orange, the exchangeable also offered gain on the Orange shares until BAe and its joint bookrunners deter- a number of advantages. The potential investors decide to exchange the bonds. mined appropriate allocations for premium on the exchangeable offered Furthermore, due to the provisional call investors in the evening. The pricing a bullish signal to the market, indicating feature of the exchangeable bonds, BAe terms were then communicated to the that BAe expected further upside in the also has some control over when market at 7.30am on 23 June 1999, Orange share price in the future. In exchange ultimately occurs. with allocations given to investors at the addition, BAe will retain legal ownership same time. When-issued trading in the and full voting rights on the underlying Timetable bonds began immediately thereafter. Orange shares until exchange occurs. BAe decided to execute the offering on an accelerated timetable. Given that the Syndicate Offering structure transaction was ‘euro-only’, no offering Deciding the appropriate syndicate for Based on its corporate financing circular was required for investors at such an important transaction is an requirements, BAe decided on a seven- launch. Indeed, at launch the transac- extremely difficult task for any issuer. year, sterling denominated offering, tion was marketed by the syndicate on Generally, syndicates on convertible and issued and redeemed at par. The the basis of a one-page summary of the exchangeable offerings tend to be more coupon range was set at 3.5–3.75% for key terms and conditions of the bonds, focused than similarly sized equity offer- marketing and bookbuilding, with a with the full offering document being ings, recognising the specialist nature of premium range of 27–30%. The completed on 19 July 1999 in advance the security and the need to ensure com- exchangeable bond also offered of settlement of the transaction on 22 plete confidentiality prior to launch. investors a period of ‘call protection’ for July 1999. In this transaction, BAe chose to exe- the first three years, with BAe then able In terms of marketing, the transaction cute the offering with two joint bookrun- to call the bonds for redemption at par was announced to the market at ners, Goldman Sachs and JP Morgan, from the beginning of year four until 7.30am on 22 June 1999, with book- and a focused syndicate of two co-man- maturity so long as the share price of building beginning immediately. An agers, ABN AMRO and Dresdner Orange is then trading more than 115% intensive selling effort by the syndicate Kleinwort Benson. above the exchange price of the bonds. during the day resulted in the joint These four syndicate banks between Although Orange is a NASDAQ-listed bookrunners being able to ‘close the them offered a strong combination of 1) company, the exchangeable bonds were books’ at 4.30pm the same day. The product expertise, 2) prior relevant deal not offered to US investors. This resulted transaction was priced that evening, experience, 3) strong equity research from both structuring issues arising from with the exchange price for the bonds credentials with regard to Orange, and the potential affiliate status of BAe vis-à- based off the closing share price of the 4) a proven long-term relationship with vis Orange (given that it shares two Orange ordinary shares on the London BAe. board directors with Orange) and the Stock Exchange that day. judgement that, in any event, it would Marketing and distribution be possible successfully to place the The offering was well received by the entire deal to UK, European and other Exiting or market with over 350 institutional non-US investors. orders received during the one day of managing equity bookbuilding. Total demand generated Accounting and taxation risk of corporate by the syndicate totalled £2bn, resulting The exchangeable bond is a senior in an over-subscription level of 2.9x the unsecured debt obligation on the bal- crossholdings is an final deal size, in line with recent market ance sheet of BAe. Coupons payable on increasing priority precedent. Investor demand arose pri- the bonds are tax-deductible. marily from UK accounts (33%), off- Importantly for BAe, the exchangeable for treasurers, CFOs shore accounts (20%), Switzerland raises cash proceeds today for the com- and CEOs (12%), France (11%), Italy (8%) and pany, but does not result in a capital Germany (5%).

The Treasurer – October 1999 15 MARKETWATCH Deal Analysis

Pricing ● rapid execution of the transaction BAe was able to achieve a precedent- The offering was priced with a coupon during one-day minimised selling setting sterling offering in terms of both of 3.75% and a premium of 29.4% pressure on the Orange share price. size and pricing, which was executed on above the closing share price of During the day, the price declined by an accelerated timetable and placed in Orange (£8.84) on the day of pricing, only 2.6% (908p to 884p) on a day the market with very little pressure on giving an exchange price of £11.44 on when the FTSE 100 index declined the underlying share price of Orange. In the bonds. 0.9%, resulting in a relative change a climate of increasing focus by corpo- of only 1.7%. Furthermore, based on rates on shareholder value and so- Important lessons the historical volatility of Orange, on called ‘managing the equity account’, As the largest-ever sterling denominat- an average day the share price determining the most appropriate ed corporate Eurobond or convert- moves up or down by approximately method to exit or manage the equity risk ible/exchangeable Eurobond, the trans- 3%; and of corporate crossholdings is becoming action illustrates a number of important ● extremely tight control of information ever higher on the priority list of corpo- lessons: among syndicate members prevent- rate treasurers, CFOs and CEOs. ed rumours of the impending sale in Exchangeables are one of many solu- ● the exchangeable bond structure can the days leading up to the offering, tions to consider and evaluate, as was offer an attractive, tax-efficient exit avoiding any selling pressure being aptly demonstrated by the record- for corporates looking to sell equity created on the Orange share price. breaking BAe offering of bonds holdings in other corporates. BAe As stated by the Financial Times on exchangeable into ordinary shares of achieved a coupon of 3.75% (within Wednesday 23 June 1999, “British Orange. ■ the marketing range of 3.50–3.75%, Aerospace surprised the market yes- and despite a sell-off in the UK bond terday by paving the way for the sale Gavin Brake is an associate in the equity market that resulted in an 11bps of its stake in Orange, the mobile derivative capital markets group at increase in the underlying reference phone group, through an offering of Goldman Sachs International in London. gilt yield on the day of bookbuilding convertible bonds.” This helped The group specialises in convertibles and pricing), and a premium of ensure BAe achieved the highest pos- and exchangeable bonds, equity 29.4% (towards the upper end of the sible exchange price (£11.44) on the derivatives and equity block trades for marketing range of 27–30%); bonds. corporates.