"Bought" Convertible Bonds Grow As Banks Eye More Work
May 30, 2001
Dow Jones Newswires
By ALISTAIR MACDONALD
Of DOW JONES NEWSWIRES
LONDON -- To win more business, investment banks are taking on more risk in underwriting and marketing convertible bonds.
With so-called bought convertibles, investment banks guarantee the price of a bond and, therefore, the proceeds to the issuer. While issuers like the certainty, it's a big risk for banks. They could be left holding unwanted bonds, but they're willing to take that risk because they want a share of a booming European convertible bond market.
"It's definitely on the increase because it works for both issues and investors in volatile markets," said James Eves, head of European equity-linked origination at UBS Warburg.
Statistics on bought deals are hard to come. But this year there have been a number of bought convertible bonds. Among the more notable are Cable & Wireless Plc's (U.CW) issue of a $1.5 billion bond exchangeable into Pacific Century Cyberworks Ltd. (H.PCW), and Vivendi Universal's (V) issue of two exchangeables - EUR527 million into Vinci (F.VIN) and EUR1.8 billion into Vivendi Environnement (F.VVE).
Bankers say corporations are clamoring for bought deals, which isn't surprising. Banks guarantee a company a price so there's no risk. If the bond doesn't sell well, the bank still pays the issuer the funds it promised.
Bought deals add certainty to what is still a volatile fund raising environment, says Eves. Convertible bonds are priced on a company's underlying equity, but, with equity markets still turbulent, there can be dramatic falls between when the bond is issued and when it is sold, priced and allocated to buyers. And the lower the share price, the less funds raised.
"Having three or four days to set the price means that the deal can move around. Even spending a day in the market can see the (underlying) equity move up or down 5%," said Eves.
The increase in bought deals is also a reflection of intense competition in the convertible bond market, where banks have to be willing to take risks if they want work. They're scrambling to get in on a market in Europe that's almost doubled in the last two years. Bought deals are even more popular in the U.S. where competition is more intense.
Bankers also say that these deals are more lucrative because issuers pay higher fees for transferring the risk to investment houses.
Big, Well-Funded Banks Have Edge
If the bought convertible market grows, it will be the banks with big balance sheets that will thrive.
"A bought deal is about committing capital and only those firms with an extensive balance sheet and the will to use it are likely to take the risk," said Claude Rieffel, head of equity-linked origination at Barclays Capital.
Investment banks are well aware of the risks of being caught out with an unpopular deal on their books.
The market said Credit Suisse First Boston holding chunks of a $2.25 billion convertible deal from U.S. conglomerate Tyco International. Traders say UBS Warburg couldn't sell all of the Cable & Wireless exchangeable into Pacific Century Cyberworks, which UBS Warburg denies.
Not all bankers think bought deals are better even when they do sell.
"The misconception is that by doing a bought deal issuers get better terms," says Danny Palmer, head of equity-linked origination at Morgan Stanley. "What issuers get is certainty - but that sometimes comes at a price."
That can involve pricing the bonds cheaply - and raising less money - as banks seek to mitigate the risk of being left with unsold stock. In essence, the upside for the issuer is capped.
In fact, investors note that bought deals can be cheaper in the long run.
"In general they're a bit cheaper...investment banks want to minimize the risk in not being able to place the bonds," said Herbert Item, fund manager at RMF Investment Products.
But many investors argue a bought deal makes little difference to them. They ask the same questions of all deals: what's the price, what's the credit and will the underlying equity perform.
-By Alistair MacDonald, Dow Jones Newswires; 44 020 7842 9270; alistair.macdonald@dowjones.com
-0- 30/05/01 09-39G
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