How Woolies’ savvy hybrid issue was done


Woolworths is not just big in the land of retail. In the local capital markets, the supermarket giant is just as willing to throw its weight around.

Bond bankers tread on eggshells around group treasurer Asrar Rahman and his team. By all accounts, they are not naive about the grip they have over their carefully selected advisers. So when Rahman decided to press ahead with a $500 million to $700 million hybrid equity issue this month it was big news for the local debt capital markets scene.

A hybrid, because of its complexity, is particularly lucrative and as the redemption date of its previous $600 million listed notes drew closer, several banks pitched a replacement trade. The company engaged JPMorgan, led by experienced debt capital markets head Natalie Vanstone, to lead a euro-denominated hybrid.

JPMorgan had been involved in several US Woolworths bond raisings but it soon became apparent that following Santos’ path to Europe was too expensive. Besides, the local market would be more appreciative of a Woolworths hybrid that would translate into significantly more attractive terms.

National Australia Bank, which was co-managing an $800 million loan raising for Woolworths, was also engaged on account of its Australian retail distribution channels. Its deal team was led by hybrid expert Nicholas Chaplin.

UBS was added to the ticket as Rahman believed its long-standing track record in Australian hybrids meant it was essential. Andrew Buchanan managed UBS’s role.

For companies, hybrids are a cheap form of equity funding at a debt-like cost. When ratings agency Standard & Poor’s released its new guidelines in 2010 it didn’t take long for savvy bankers to realise they could create a hybrid security for which investors would accept a debt-like interest rate, but which would qualify as equity capital in the eyes of the ratings agencies.

Australian bankers led the charge and took capital-hungry energy giant Santos to Europe to sell the first hybrid S&P counted as 100 per cent equity. It was a matter of time before highly rated companies took advantage of this “credit rating arbitrage" – raising non-dilutive equity at a debt-like rate of interest.

Woolworths, which had hybrids worth $600 million due for redemption in September 2011, was a prime candidate. When word got out that a deal was in the works, other banks fought furiously for a role on a trade that was expected to be a guaranteed success. But it wasn’t that simple.

The challenge for Woolworths’ advisers was setting the interest rate of the first major corporate hybrid in more than four years. The best reference point was the 3.10 percentage margin over the bank bill rate ANZ Banking Group paid in August when it raised $1.25 billion of hybrid capital.

Because banks played a starring role in the global financial crisis, institutional investors now lend money to stable non-cyclical companies such as Woolworths at a better rate. Would retail investors do the same? Woolworths, and its advisers, wanted to set a rate that would attract institutional interest as an insurance if the retail interest fell flat. But at the 3.25 percentage point minimum margin (added to the bank bill rate to yield around 8.05 per cent) small investors were enthusiastic participants.

An estimated $5 billion flood of money was directed Woolies’ way as everyone from Sydney hedge funds to widowed retirees from Wagga Wagga bid for the notes.

The strategy of pricing for the big end of town proved problematic. Brokers and planners were so bombarded that tensions between Woolies, its banks and dealers threatened to boil over.

With an estimated $5 billion of total bids from retail and institutions, Woolworths would have to disappoint eager punters on both sides by drastically scaling back bids. The overwhelming order book meant the general offer of the bonds was cancelled and a paltry $25 million would be offered to shareholders, fuelling anger among small investors who wanted the notes. About $175 million was placed with institutions and $500 million given to brokers to sell to their clients.

The “Woolworths Notes II" are expected to “pop" by 2 per cent when they list. At a $102 face value, they will trade at what many say is the right margin of 2.50 percentage points over the bank bill rate, but that is with the benefit of hindsight. Woolworths exposed a vast pool of Australian savings hungry for yield. Its mistake was underestimating just how vast and hungry.

The Australian Financial Review