Payment-in-kind bonds, where the borrower can in some circumstances defer interest payments until maturity, are one of the most aggressive instruments in the high yield bond issuer’s toolkit.
Usually they tend to be used only by the most highly indebted, private equity-owned companies, especially where the sponsor wants to pay itself a dividend. This year, Schaeffler — an impeccable, family-owned pillar of the German Mittelstand — has made PIKs fashionable, perhaps even respectable.
In July, the Ba3/B+ rated German ball bearing group raised €1.5bn-equivalent with one of the largest PIK bonds ever sold, though it used the more investor-friendly toggle structure where interest is only deferred and added to the principal if the company misses financial tests.
Schaeffler’s debt issues go back to 2008. It had historically been flush with cash, but loaded itself with debt when it bid for a minority stake in Continental, the tyre maker. The deal blew up in Schaeffler’s hands, because when stockmarkets crashed, far more investors than it had expected took up its low-ball offer to buy shares.
Schaeffler ended up having to buy 89% of Continental, at a cost of €11bn.
Under the leadership of Klaus Rosenfeld, who joined as CFO in March 2009, Schaeffler began a series of refinancings and corporate restructuring steps to tackle the debt.
First, it split the acquisition debt into €7bn at the Schaeffler Group operating level and €5bn at Schaeffler Holding. Early in 2012, the operating company sealed an €8bn bank and bond refinancing.
“Gaining access to the capital markets was the key to success for our refinancing story,” says Christoph Beumelburg, head of investor relations at Schaeffler in Herzogenaurach. “With the inaugural bond and institutional loan transaction we paved the way for the successful redesign of our capital structure.”
The company then issued a retail bond in July 2012, improved some terms and conditions of the loans in December and repriced its institutional loans in February 2013. It raised two more operating company bonds in April.
Tackling the holdco debt
“Having optimised our capital structure at the Schaeffler AG level over 18 months, and given the favourable market environment, it was the logical next step to address the indebtedness at the Schaeffler Holding level,” says Wolfgang Boersig, head of treasury at Schaeffler.
The initial holding company debt of around €4bn was mainly in the form of PIK loans, which meant that it had accumulated to a higher figure over the years. In September 2012, the burden was reduced by around €1.6bn to €3.6bn, when Schaeffler sold 20.8m of Continental shares.
In July 2013, Schaeffler refinanced all its now €3.925bn of holdco debt with €1.5bn-equivalent of PIK toggle bonds, rated B2/B+, and €2.175bn of pre-arranged four year holdco loans. The two debt tranches are pari passu.
With tranches of €800m and $1bn, the five year non-call one bond was the biggest and tightest-priced PIK toggle ever issued globally, according to a banker close to the deal.
With 6.875% coupons, the euro tranche was priced to yield 7.25% and the dollar 7%. The refinancing will cut Schaeffler Holding’s average interest rate by around two percentage points to about 7%.
“The banks, which joined the syndicate at the Holding level, contributed considerable new money in the form of loans, which reassured bond investors, who were making an investment decision,” says Thomas Ditt, head of capital markets at Schaeffler.
“The proactive investor relations work that we have started over two years ago is paying off,” Beumelburg says. “Investors understand that we have a strong operating business and therefore perceive us as a strong credit. Not only can we tap the market more or less at any point in time, we are now in the position to execute transactions much quicker. This was also very important for the holdco PIK toggle bond, where our main task was basically to explain the structure of the instrument.”
The holdco bonds and loans have a security package, which includes pledges over 100% of the shares of Schaeffler AG and 13.8% of Continental, which has a market capitalisation of around €23bn.
And despite the bond’s PIK characteristics, Boersig stressed that Schaeffler intended to pay the coupon in cash until maturity.
“The PIK toggle structure has to be understood as a safety feature,” he says. “It is the clear intention to pay bond interest in cash unless something entirely unexpected happens.”
A banker at one of the bookrunners, Deutsche Bank, JP Morgan, BNP Paribas, Citigroup, Commerzbank, HSBC and UniCredit, said the transaction was sold to a broad array of European and US investors, including managers who do not usually buy PIK bonds. That raises hopes that the investor base for PIKs could increase.