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Strong appetite for European convertible deals

Banks have structured some unusual and complex deals for European companies to raise capital through a combination of debt and equity derivatives in recent weeks, reflecting investor enthusiasm for convertible securities.

Last week BASF launched a $600m bond bundled with warrants, in a so-called neutral structure which effectively makes the chemicals group a middleman between its investors and its banks. 

The deal, put together by Deutsche Bank, means the company gets cheap funding while avoiding having to issue shares which dilute the value of stock held by existing shareholders. Instead the warrants can be used to claim a cash payment based on the BASF share price in the future, which the company meets through an offsetting financial arrangement, or hedge. 

A typical convertible bond comes with an embedded option, which gives an investor the right to redeem the bond in exchange for stock, provided the share price has reached a certain level. 

Jasper van Ingen, an investor in convertible bonds for NN Investment Managers, said “companies can get away with giving away less value”. He added that new deals were needed to replenish the market, as “compared to the demand there is a lack of paper”.

Edward Sankey, co-head of equity capital markets in the region for Deutsche Bank, said the BASF deal was a sign of the robust demand for equity-linked issues as well as blocks of stock more generally seen so far this year. 

“Currently we have constructive markets with low levels of equity market volatility and some inflows to equity funds. However, with low liquidity in some situations, a capital markets transaction is often an efficient way for investors to access the market,” he said. 

The structure of BASF’s bond has been rarely seen in recent years, used in a Siemens deal in 2012 and by Brenntag, a chemicals distributor, in 2015.

BASF’s bond also included a final element, issuing in dollars then using a so-called basis swap trade to turn the dollar proceeds into euros, similar to US bond deals conducted this year by luxury goods group LVMH and Michelin, the tyremaker. 

The unusual bond follows a three-part €1.3bn deal for Deutsche Wohnen the previous week, which bankers said was a first for Europe. The German property group simultaneously sold an €800m convertible bond, €500m of new stock and repurchased €250m of convertible debt issued in 2013. 

“It demonstrates market capacity to absorb large and complex transactions,” said Javier Martinez-Piqueres, head of equity capital markets in the region for UBS, which led the transaction with Deutsche Bank and Goldman Sachs.

He said the company had a positive story to tell about a boom in German real estate and the appetite for capital linked to growth, but also that “investors are long cash and looking for opportunities”.

The Thomson Reuters European Convertible bond index has returned 1.9 per cent so far this year, compared with gains of just 0.3 per cent for the whole of 2016. 

“Our clients look at converts as a way of protecting themselves from rising interest rates,” said Stephan Bach, a portfolio manager for Sparinvest.

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