Outlook 2015: U.S. convertibles primary notches multi-year high; volume expected to climb

By Rebecca Melvin

New York, N.Y., Jan. 2 – New issue volume for U.S. convertibles is expected to remain strong in 2015, reaching $55 billion to $60 billion, which represents a continuation of the current trend for small, but steady improvement in the new deal tally, several market sources said.

“We think there will be a continued slight increase but no real catalyst for a huge increase. A lot will depend on stock prices staying up,” a New York-based syndicate source said.

Total new issue volume for 2014 was $51.3 billion in 140 deals as of Dec. 23, which just edged 2013’s total $49.3 billion in 157 deals, for a 4% increase, according to data compiled by Prospect News.

It was the first year since the financial crisis that the market was net-supply positive.

Volume in 2012 fell to a multi-year low of barely more than $20 billion in deals and was not much more than $25 billion in deals priced in 2011.

Sources think that the current rebound will continue as issuers tap a market with strong investor demand, lower yields compared to the straight bond markets and premiums that remain high, albeit generally lower than at the beginning of the year.

Among 2014’s largest new deals were a number of large mandatory convertible offerings, including several that came in the last few weeks of the year. They included Fiat Chrysler Automobiles NV’s $2.875 billion of 7.875% mandatory convertibles, T-Mobile US Inc.’s $870 million of 5.5% mandatory convertibles, and WMI Holdings Corp.’s $600 million of 3% mandatory convertible preferreds, which was the year’s last deal, pricing on Dec. 19. WMI Holdings is a Seattle-based reinsurance business.

The year’s other large mandatory deals included Exelon Corp.’s $1.15 billion of 6.5% three-year mandatory convertible equity units, which priced June 12, and Dominion Resources Inc.’s $1 billion of 6.375% equity units, which priced a few weeks later.

Exelon, a Chicago-based electric and gas utility, used proceeds to finance part of its Pepco Holdings Inc. acquisition, and Dominion, a Richland, Va.-based energy company, used part of its proceeds to fund a liquefaction project.

Mandatories accounted for a “meaningful” amount of issuance, but bonds remain the dominant structure for issuance, according to Barclays’ U.S. Convertibles Outlook 2015 report.

Mandatories accounted for about 19% of issuance in 2014, Prospect News data shows.

The most active business sectors issuing convertibles were information technology and health care. Energy also accounted for a decent 7% chunk, but the deals were less abundant than financial issuers, which accounted for 11% of issuance.

Early in the year, Citrix Systems Inc. priced $1.25 billion of 0.5% convertibles that traded up out of the chute after the Fort Lauderdale, Fla.-based cloud computing solutions company priced the bonds at the midpoint of talk. Hedge players made money on the new Citrix convertibles, which gained on underlying shares that were fractionally lower.

In March, Herbalife Ltd. priced $1.15 billion of 2% convertible bonds, which dropped below par on their debut after the Cayman Islands-based nutrition company priced at the cheap end of talk.

Midyear pricing shift

Deals that priced during and after a flurry of new issuance in August began to suffer if priced too aggressively as the convertibles market began to stutter from a combination of factors including wider high-yield spreads.

Priceline Group Inc.’s $1 billion of 0.9% convertible senior notes that debuted on Aug. 15 were reoffered at a discount to par of 99 and slipped slightly below 99 in first-day trading. The paper was flat on a dollar-neutral, or hedged, basis, however.

Six other deals that also priced that week for about $2.23 billion in base deal proceeds had mixed debuts.

The other deals included AOL Inc.’s $380 million of 0.75% convertibles, which outperformed the rest of the field, adding 3 points on swap on their debut; Apollo Commercial Real Estate Finance Inc.’s 5.5% convertible senior notes, which sank after the New York-based real estate investment trust priced a $100 million add-on to that issue; and Aegerion Pharmaceuticals Inc.’s 2% convertibles added about 0.5 point on swap after the Cambridge, Mass.-based biopharmaceutical company priced an upsized $300 million of senior notes at the rich end of talk.

It was the busiest week for the U.S. convertibles primary market since early June, and it marked the beginning of a shift in pricing in favor of investors. Particularly, the largest offerings couldn’t be priced as aggressively as they had been before.

In September, Alcoa Inc.’s $1.25 billion of 5.375% mandatory convertible preferreds slipped below par on their debut after the New York-based aluminum producer priced the securities toward the cheap end of talk.

Other marquee names in the autumn lineup had mixed debuts. LinkedIn Corp.’s deal gained and did well for hedged players, but Twitter Inc.’s two upsized tranches, which priced Sept. 11, traded weakly on their debut and remain well below par.

Deal volume in 2014 through mid-September was stronger than 2013’s, then it was weaker, a syndicate source pointed out. It rebounded in mid-October from its low point, he said.

Abundance of smaller deals

The year was also characterized by a large number of issues from small capitalization companies. There were small deals from biotechnology companies such as Peregrine Pharmaceuticals Inc., Oncothyreon Inc. and Synergy Pharmaceuticals Inc. And other sectors were represented as well, with deals by Cardica Inc., which makes automated anastomotic systems for cardiac bypass surgery, and Amyris Inc., which makes renewable specialty chemicals and transportation fuels.

Mid-size issuers that brought meaty $400 million to $600 million issues were notably few. According to data that didn’t include the very end of the year, only 19 deals, out of 123, were in the size range of $400 million to $600 million, according to Prospect News.

The type of deals that “anyone at all can buy went MIA, a New York-based trader said.

There was good demand from the investor side, a second New York-based trader said, but issuer demand for capital in that area must have lagged.

“They could have gotten them done. There was a lot of pitching going on,” he said.

One mid-size deal that did price was one of the year’s best, a New York-based trader said.

Jazz Pharmaceuticals Inc.’s $575 million of 1.875% exchangeable senior notes due 2021, which priced in early August, strongly outperformed its underlying shares – at least on an outright basis – in the early weeks after pricing. The bonds moved up to 110.5 bid, 111.5 offered and to as high as 112.125, which was up more than 2 points, on Aug. 20, when the shares added $1.43, or 0.9%, to $158.30 on the day.

A smaller $250 million issue of 2.5% convertibles from Live Nation Entertainment Inc., a $5 billion market cap company, gained on swap after the Los Angeles-based concert promoter and music venue manager priced at the rich end of talked terms.

“Little deals that get priced right do well. The market was standoffish on the big deals and the mandatories. A lot of Fiat went to retail. T-Mobile traded OK. I’d like to see more. The small deals got priced well, and there was good demand,” a New York-based trader said.

New issue stand outs

Deals that market players pointed to as the year’s best included Illumina Inc.’s A and B tranches for $633 million and $518 million, respectively, which put in a lackluster debut after the San Diego-based developer of genetic research tools priced the upsized deals at the rich end of talked terms, but which subsequently improved after Standard & Poor’s assigned an unsolicited corporate credit rating to the company.

S&P assigned Illumina its BBB- unsolicited corporate credit rating. It also assigned its BBB- unsolicited issue-level rating to the $1.15 billion of convertible notes.

The rating agency said its rating reflects “the combination of a tightly focused competitive position in the life sciences industry and a lightly leveraged balance sheet, characterized by ample cash balances and good cash flows.”

There has been some volatility in the shares, which moved with overall equity market swings, but they are currently up about 12% from when the issue priced in June.

“After it got its rating, these were up a lot, to a point where they were super rich,” a New York-based trader said.

“They trade about high 40s implied, and the stock realizes upper 30s,” the trader said in late December. “Someone is out buying them today.”

Illlumina’s lackluster debut was attributed to the pricing. The bonds priced at the rich end of talk, including at 55% initial conversion premium.

“I think guys were surprised by the 55% premium,” the trader said.

On a hedged basis, the A convertibles slipped 0.25 point, and the B convertibles slipped about 0.5 point on first-day trading.

“The stock bailed out the convert,” a second New York-based trader said.

Proceeds were used to repurchase a portion of Illumina’s 0.25% convertibles due 2016. Remaining proceeds were for general corporate proceeds.

Isis Pharmaceuticals Inc.’s 1% convertible bonds also didn’t sport a great debut, but interest in the paper has grown. The Carlsbad, Calif.-based developer of gene-based therapeutic drugs priced $425 million of the seven-year notes at the cheap end of talked terms.

On first-day trading, “the stock didn’t cooperate, and the bonds were heavy right from the get go,” a New York-based trader said.

On a delta of 75% to 80%, the bonds contracted about 0.25 point even though shares were lower.

After broader market swings took its equity and its convertibles to lows at the end of November, there has been significant interest in the convertibles, a trader said.

Tesaro Inc.’s 3% convertible bonds put in a relatively strong debut and the issue remains on the radar of players in health care names.

The Waltham, Mass.-based biopharmaceutical oncology company priced an upsized $175 million of the seven-year notes at the cheap end of talk – with the greenshoe, the deal is $201.25 million in size.

Tesaro shares fell 9% after the deal was launched and were slightly weaker on the bonds’ debut. But the bonds moved up in price anyway to about 102 with the stock around $26.00. On a hedged basis, they were up 1 point to 1.25 points, a syndicate source said.

There was “healthy, two-way flow, with better buying interest as the morning progressed,” the source said.

“It came pretty cheap,” a New York-based trader commented.

Proceeds will be used to fund the capped call transactions and to fund Tesaro product candidates, including rolapitant and niraparib, to carry out Tesaro’s immune-oncology platform strategy, and for working capital and general corporate purposes.

Year starts with tight terms

In recent years, new issue pricing has moved in favor of issuers. Average cheapness of new issues in 2014 was 0.9%, compared to 1.2% cheap in 2013 and an average of 2.5% cheap in 2010 to 2012, according to Barclays’ year-end outlook report, “Setting to Sail.”

Among the deals this past year that came at the tightest terms was Akamai Technologies Inc.’s $690 million of 0% convertibles due 2019, which came with a 50% initial conversion premium. This deal priced in February and was able to move slightly higher out of the chute, before slipping slightly lower.

The Cambridge, Mass.-based content delivery and cloud infrastructure company priced the upsized deal at the tight end and beyond the tight end of talked terms. Price talk was for a 0% to 0.5% coupon and 42.5% to 47.5% premium.

In fact, 18 deals this past year priced with a 0% coupon, and the majority of deals got done with coupons of 3% and lower, according to Prospect News’ data.

Deals that came with coupons with a higher, 4% handle included the likes of Tyson Foods Inc.’s 4.75% convertible tangible equity units, LGI Homes Inc., Violin Memory Inc., TPG Specialty Lending Inc., and PDL BioPharma Inc. And deals with coupons above 4% were less abundant.

Nevertheless, there has been a return of fund flows into equities and the convertible product, and there is a diversified fundamental buyer base including credit and equity, on the demand side, Barclays said in its U.S. convertibles outlook report.

The demand side started to balk about pricing around midyear. But the supply side remained encouraged due to a combination of factors including the strong equity rally, M&A trends, small- and mid-cap growth capital raisings, stock buybacks, and Chinese issuer presence, according to Barclays.

“We expect these trends along with rising capital spending by U.S. corporates to continue to drive issuance. Any potential increase in rates and credit yields would likely provide further impetus to convert issuance,” Barclays said.

© 2015 Prospect News.
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