Conversion premium

Convertibles flurry show issuer power

The easy money has been made in European convertible bonds — but that doesn’t spell an end to investor demand for bonds that turn into shares. Companies capable of concocting attractive convertible bond issues are in sweet spot right now.

Sales of convertible bonds in Europe more than doubled to Euro 17.7 billion last year, according to Barclays. Two very different deals this week underline how favourable conditions are.

ArcelorMittal’s $2.25-billon (Euro 1.7 billion) mandatory convertible is only the second such deal in as many years, after Volkswagen reopened the market in November. Mandatory convertible bonds automatically turn into shares in the issuer after a set period, with investors receiving a high coupon in the meantime to compensate for the forced conversion. Rating agencies treat mandatories as equity from the get go, even before conversion. For Arcelor, the deal will help cut debt, but defers shareholder dilution.

As demand for higher-yielding assets has grown, so the cost of issuing mandatory convertibles has fallen by about one percentage point in annual interest terms, according to one banker, making them even more attractive to issuers. Arcelor was able to raise $500 million more than planned.

Demand is such that even issuers from peripheral economies can easily get deals away. Spanish engineering group Abengoa sold a conventional Euro 400-million convertible, giving investors an option rather than an obligation to convert into shares at a set price. Investors placed over Euro 1 billion. The deal was originally only expected to be Euro 250 million.

Why the clamour? A sell-off in 2011 left convertible bonds trading at a level that underpriced the value of the embedded option to convert into equity. But a subsequent rally means European convertibles are no longer cheap from that perspective. So, while convertibles returned about 16 per cent last year, a more pedestrian mid-to-high single-digit returns in 2013 is likely this year, according to one investor.

Still, demand should hold firm. Investors seeking yield have few alternatives. Some may be forced buyers, as a slug of bonds issued by highly-rated companies is set to mature this year. A rising stock market also clearly helps. Issuers have the upper hand — they should exploit it while they can.