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Treasury & Capital Markets / Europe / Viewpoint
European companies: beware the irrational China premium
How will Chinese majority control impact a company's debt funding costs in the future?
Keith Mullin 4 Jul 2018

When Global Switch's seven-year 5.5% euro bonds matured in April 2018, the London-based company's treasury team had cause to be apprehensive about the future.

A month before, the owner, operator and developer of large-scale data centres in Europe and Asia-Pacific had conducted an optional redemption exercise on three lines of bonds in Australian dollars, sterling, and the about-to-mature euro notes.

In the event, investors passed on the opportunity, redeeming less than 0.5% of relevant outstanding notes. The company had in any case undergone a major funding and liability management exercise in 2017, buying back large chunks of its Australian dollar and euro bonds via tender offers, and selling EUR1 billion in new seven and 10-year maturities.

The net result of the flurry of activity was clear: following the tender offers and new issue, the company's weighted average debt maturity lengthened from 2.2 to 5.9 years and the weighted average cost fell from 5.1% to 3.2% and, following the April 2018 bond maturity, to 6.0 years and 2.8%. Early in 2017, Global Switch had closed a new GBP425 million revolving credit facility that was not only upsized but came with a sub-100bp margin.

Overall, that's an impressive result. So what's there to worry about?

Well, in December 2016, the Reuben Brothers, the billionaire investors who owned Global Switch, had sold a 49% stake in the company to Elegant Jubilee, a consortium of predominantly Chinese corporate and institutional investors. The consortium was put together by telecoms and internet entrepreneur Li Qiang and led by Jiangsu Sha Steel.

The key event came at the end of 2017 when the consortium acquired an additional 2% of the company, taking its stake to 51%. It was that switch to majority control that triggered those put options on the bonds.

On July 3 2018, Strategic IDC Ltd, a consortium of six new and existing Asian institutional and private investors, acquired a further 24.99% stake in the company in a transaction valued at GBP2.1 billion; China CITIC Bank International provided debt funding. Following the transaction, the Reuben Brothers (via Aldersgate Investments) will own just 24.01% of the company; Elegant Jubilee will maintain its 51% stake.

And it was that switch, presumably now conflated by the additional stake sale, which has caused a bigger worry: how will Chinese majority control affect the company's debt funding costs in the future?

Because here's the thing: international investors, including the universe of predominantly European investors that ply their trade in the euro bond market, demand a China premium that is irrational on technicals and which ignores ratings and other credit factors. Contrast, for example, the US$500 million three-year dollar floater sold by ICBC London – a unit of the biggest bank in the world – in mid-June at 75bp over Libor with same-rated Bank of Nova Scotia's U$700 million three-year line just weeks earlier going out at 44bp over.

The case of Energias de Portugal (EdP) is a more nuanced example. China Three Gorges Corporation (CTG) launched an offer for a full takeover of the Lisbon-headquartered global energy conglomerate on May 11. CTG has had a 23.27% stake in EdP since 2011 (the Portuguese government had to sell the stake as a condition of its EUR78 billion sovereign bail-out) so the China factor has long been evident.

Before the May 11 takeover bid, CTG's outstanding seven-year euro bonds were quoted around 75bp over mid-swaps. EdP's euro sevens were trading through CTG in the 55bp-60bp area. The 15bp-20bp differential is stark taking into account the respective ratings. CTG is a strong Single A (A1/A+/A+) while EdP is on the lowest rung of investment-grade (Baa3/BBB-/BBB-). That's five notches of difference. And EdP was only upgraded from junk ratings levels a year ago.

Bear in mind also that CTG is ultimately 100% owned by the People's Republic of China, whereas EdP's major business is located in a peripheral Eurozone country that is still rated sub-investment grade by Moody's (Ba1). If ever there was a screaming switch trade pre-bid, it was sell EdP buy CTG to pick up the extra spread on a related credit.

Fast forward to June. CTG has made its bid and the two sides are talking turkey. EdP's board thinks the bid price is too low and is pushing back; CTG, meanwhile, is already shopping EdP's US renewables business around to deter any blocking action by wary US authorities, and the Portuguese stock market regulator (CMVM) is doing what is can to get the deal over the line.

In the midst of this activity, China-tinged EdP tapped the market on June 20 with a EUR750 million long seven-year 1.625% bond. It printed at 105bp over mid-swaps. That's 35bp-40bp wide of where it could have printed pre-bid.

Sure, the deal was priced to sell, coming as it did in the wake of some severe Italy-inspired volatility that had sucked in other eurozone peripherals and roiled general bond market sentiment. But the fact that fair-value estimates for the bond excluding the new-issue premium were in the mid-90s, which is exactly where CTG bonds had widened to in the aftermath of the euro market volatility, looks too neat to be a coincidence.

Long-story short, Global Switch now seems destined to pay up to access the bond market. European companies take note.

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Diwakar Vijayvergia
Diwakar Vijayvergia
senior vice president and portfolio manager, Asia fixed income
AllianceBernstein
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Edmund Leong
Edmund Leong
managing director and head of group investment banking
UOB
- JOINED THE EVENT -
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