Flexibility is a key feature of convertible bonds, and means that new deals can be positive for both issuers and investors, as opposed to a zero-sum game. We see that dynamic at play in a new EUR 500 million, 3-year maturity exchangeable bond launched after the European market close on 16 February by FEMSA—Fomento Economico Mexicano SAB de CV, the major Coca-Cola bottler in Mexico—that converts into shares of Heineken Holding NV (HEIO).
Exchangeable bonds can be a highly useful tool for large holders of listed stocks to monetize these holdings. In the case of FEMSA, which took a stake in the Dutch brewer more than 10 years ago, the company has just concluded a strategic review with an outcome to divest its Heineken holding. Using a convertible structure where an option is embedded into bond represents (in part) a forward sale of its Heineken stock that holding that can be delivered upon conversion, but at a premium to today’s price, and without selling that stock directly into the market. In return, investors that subscribe to the deal receive an option on a well-known blue-chip consumer stock that is new to the convertible bond market and can do so in the form of an expected investment-grade rated instrument with decent coupon and reasonable equity sensitivity.
This new exchangeable bond was brought to market by three banks: Bank of America, Goldman Sachs, and Morgan Stanley. It can convert into shares of Heineken Holding (HEIO), which holds 50.01% of the shares of Heineken NA (HEIA). FEMSA’s strategic holding in Heineken was structured via shares of Heineken Holding, where the Heineken family and other holders control just over 50% of those shares. The coupon range was set between 2.375% and 2.875%, with a conversion premium range between 25-30% placed off a concurrent equity offering of EUR 3 billion in shares of Heineken Holding NV (HEIO) and Heineken NV (HEIA). (On the morning of 17 February, the final terms of the deal were set at 2.625% and 27.5% premium, so at the middle of the marketed range.) Heineken made a commitment to purchase shares in the equity offering of both lines of stock, which should support the overall stock placement and minimize the discount required to place these shares. An interesting aspect of the stock placement for the exchangeable is that there is an allocation for delta-hedged holders to offset the short stock position they would usually set up as part of their strategy, further minimizing impact to Heineken Holding stock. These exchangeable bonds will carry some dividend protection, meaning that dividends paid above a threshold amount (EUR 1.73, or a yield of roughly 2%) will be compensated by an adjustment to the conversion ratio so that exchangeable holders will receive additional stock.
We felt that the assumptions from the lead banks (credit spread of 80 basis points, stock borrow cost of 40 basis points, and volatility of 22%) appeared reasonable, and that the exchangeable bond would likely be well received by all players in the convertible bond market. Long-only investors can now get exposure to Heineken, which is a high-quality name in a sector where there is currently no exposure in our market. (We have seen brewers issue convertible bonds in the past, including Asahi and MolsonCoors, as well as a smaller exchangeable issued by Spanish brewer Damm into shares of Ebro Foods.) The output delta when using the leads’ assumptions comes out in the mid-30s range, and that equity sensitivity is geared more towards the community of long-only, directional holders. Some brokers not involved in the underwriting have made their own assumptions to arrive at a fair value range of just below par to par. Still, we think the deal can still work for delta-hedged, relative value investors. The presence of a delta placement should help avoid spikes in the stock borrow cost (a higher cost to short stock reduces the potential return from the hedged position) and many of these delta-hedged investors may subscribe if they imagine these bonds will be in high demand by long-only investors, which could cause the price of the exchangeable bonds to richen. In sum, something for everyone.
Selling this exchangeable bond along with a stock placement allows FEMSA to monetise about half of its position in Heineken, and the speed and flexibility of this total transaction is clearly helpful to the issuer. There may remain an overhang on the Heineken stock price if FEMSA continues to sell shares into the market. That said, the presence of a meaningful coupon for investment grade credit reduces the possibility of a hangover to holders of the exchangeable bond, as does a conversion premium that incorporates the discount incorporated in the stock placement price.
Key Information
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