Belgacom Case Study

Belgacom Case Question 1 a) wherefore did the shargon expense of Belgacom increase following the announcement of the accomplishment? b) Why did the orders of Belgacom drop (S&P) or flummox on prejudicial watch (Moodys)? a) As Belgacom secured the purchase of the extending 25% share of Proximus it did non hire got yet, the share expenditure of the Belgian connection increased by 0. 92 % the same day and 9. 8% over the following month. An announcement fecal matter lead to pre-event abnormal returns as market home bases react to this information to cling a premium.Investors allow for try to assess the increase in pass judgment earnings and dividends. The pretend of this sagacity will depend on how the merger is done, how the transaction is paid, the sector it concerns, etc. However, jibe to market capacity theories, overreaction on stock prices tend to disappear in the long-run and the price reflects the present value of expected returns. (FAMA, 1998) That being sai d, several reasons may explain this jump.First, we can underline the item that this operation enables Belgacom to collect completely the benefits of Proximus. Before the purchase, 25% of the earnings of Proximus were placed in minority worrys, these were payable to Vodafone. After the operation, Belgacom owns 100% of the shares and can enter all the cash of its subsidiary in its accounts. It represents an increase of the emerging cash flow not unless for the firm but as well as for its current shareholders, which will be comforted to receive more than in the future or that their shares represent more cash.This is due to the decision of Belgacom to finance its acquisition by debt which doesnt give ownership rights to the pose owners. public figure. 1 Evolution of Belgacom Share set ( two hundred5-2008) indorse, Belgacom was familiar with Proximus vocation as Belgacom (75%) founded the company with Airtouch (25%) in 1994, creating by this way the low gear mobile phone op erator in Belgium. b) Unlike the market, rating agencies did not welcome positively this transaction Moodys limitingd its outlook to negative and Standard&Poors down gulld Belgacom rating to A from A+. Moodys xplained that it keeps Belgacoms rating unchanged beca enjoyment accord its methodology designed for GRI (Government-Related recognises), thither is no change in Belgacom solvability. Moodys GRI methodology use three inputs the rating and the outlook of Belgium, the low level of default dependence and the medium level of backing from the Belgian government. While there is no change in those inputs, there should be no change in Belgacom rating. That being said, several indicators lead the agency to wonder about the ability of the Belgian company to deal with its creedors.First, Belgacom announced a bunch of outflows for the months to come just at the same succession, Belgacom decided to dish out its 5,8% stake in Neuf Cegestel to SFR the outcome of the operation was EUR 1 87 million positive a share buyback (maximum 200 million) and a dividend in 2006 for EUR 100 million. Futhermore, Belgacom decision to use its current financial stability and and then offend its debt ratios. As for Standard&Poors, the agency decided to downgrade the rating of the Belgian firm from A+ to A.S&P said this decision lies on the fact that the Belgacom debt will rise of about EUR 2 billion, making notably increase the debt/Ebitda ratio from 0,8 to 1,9. Moreover, its business in a competitive and liberalized market, as well as the turn away of fixed lines market make fear for future results of the company. However, the outlook re chief(prenominal)s stable, that can be explained by the strong position of the company on the Belgian telecom market and its huge ability to make cash. Question 2 a) Why was the acquisition financed by a two several(prenominal) impart? ) What were the alternative backing sources? a) Bridge lends are short-term financial instruments normal ly utilize to lock-in a settled price( (frequent in concrete E introduce Market). This practice buys time for the deal maker to sort things out and to intermit structure its financing scheme. This seems to be the main rationale for Belgacom in this berth. The management requiremented to lock-in the price agreed on with Vodafone and as the deal was subordinated to the Belgian Authorities approval, it was more cautious to make it happen right away.Yet there is close to other way to see a pair loan as a temporary expensive loan serving the purpose of being an intermediate financing mean for the company that benefits from it (Fabozzi, 1991). Later on, this bridge loan is reimbursed with more advantageous types of loans. was in fact a syndicated loan underwritten in nightclub to finance an acquisition. As a matter of facts, the loan was do by several lending institutions called the mandated lead arrangers i. In the case of Belgacom, the company took a bridge loan for several r easons that are detailed below.The bridge loan e. BNP Paribas, Citi, Fortis, ING and JP Morgan. For the enthronization lodges that underwrite the syndicated loan, the main interest resides in the fact that they gain a fee. In this specific case, the bridge loan was arranged as a revolving opinion instrument type. This meant Belgacom had to pay a fee plus interest expenses and can draw-repay-redraw as many times as needed. As said before, a first valid reason would be that the cash was needed quickly (maybe) and bridge loans are arranged more quickly.In any case it is in the best interest of the company (Belgacom here) to reimburse the bridge loan as quickly as possible because it is very expensive and the interest reckon generally increases with the maturity date. Moreover publicize collective bails takes time. In fact, there are four main steps to issue a aspire in the bewilder market. First, there is the pre-mandate phase which aims to determine the backup needs or whet her it is the right time to tap the bond market. Additionally, the currency has to be determined, the market as well plus the channelizeed investors.After that, comes the track record structure process which is one of the most of the essence(predicate) tasks that represents of taking the orders from the investors. Then, a range for the verifier rate has to be determined and the quantitys confuse to be allocated to the investors. Those steps could typically take weeks. Helping companies with short term financial support is thus a study need for the client. Another reason may be that it gives Belgacom time to example for more favourable economic conditions for offspring the bonds. Depending on investors appetite, timing is in fact of import in such deals.Now, from the investment banks perspective, there is possibly a conflict of interest as the investment bank is at the same time creditor (through the bridge loan) and the entity that prices the securities that will be us ed to reimburse this loan. One could argue the investment bank could lack objectivity (Glazer, 1989). However, this constitutes an augmentitional incentive for the platter runners to successfully carry the deal to its end. Additionally, four of the five banks that granted the bridge loan became the joint book runners. To that extent, there are clearly business interests which are involved.This can be interesting for the investment bank in order to get closer to the client. Moreover, this form of short term financing is more expensive for the company because it bears broad(prenominal)er run a chances. Alternatively, it means that it is more lucrative for the investment bank as well. To sum up, bridge loans seem to be a lucrative source of utilitys for investment banks. First, they place themselves in a comfortable position to issue bonds for the company later on. Second, they can diversify their taxations and be a total candidate for the bond issuance.As a matter of facts, fo ur of the five banks providing the bridge loan took care of bond issuance. b) Alternatives to bridge loans were traditionally letters of comfort written by the investment bank stating that the bank was passing confident that the additional financing needed by the company could be obtained. This implies no bridge funding at all. Hence the alternative would be to wait for the bonds to be issued. The risk here however would consist of being too late for acquiring the target. Another alternative would be to use your own gravid to fund the acquisition in the short run.This depends, of course, on the ability of Belgacom to generate such a thumping amount of cash. Yet another option would have been to raise more capital by issuing shares with the agreement of its existing shareholders. However, this option could have been detrimental to existing shareholders the Belgian state which had a major stake in Belgacom with 50. 1% of the shares. Here is a summary of all the plausible alternativ es * Pay with well-kept cash Belgacom could put 2Bn on the table for Vodafones stake (assuming that the amount was available at the time).Although, this is know as the worst case scenario for current shareholders. Putting the cash in an acquisition would also have constrained Belgacom to lower (even cancel) its expansion investments. * Go straight to the Market Belgacom could issue the bonds without taking the bridge loan but since the company had no prior bonds outstanding in the secondary market, the pricing would have been indispensable anyway and it takes time and money to process it. The risk in that case is the agreement with Vodafone other players could profit from the info and buy the stake in order to sell it back to Belgacom at a premium.Question 3 Assuming the 5- class change rate was 3. 922% and the 10-year swap rate was 3. 977% at the time of pricing the deal (primary market), could you enter a) The yield for investors The yield is composed of the risk-free interest rate and the risk premium. The risk-free rate is usually defined as the rate of a government bond or the interbank rates (ex Euribor) for the same maturity. However, the swap rate is used for maturities beyond 12 months. Here, the informative statement assumes that the 5-year and the 10-year swap rate were respectively 3,922% and 3,977%.The credit afford or risk premium depends on the maturity and the quality of the issuer. After comparing the coupon offered by companies with the same risk profile from the telecom peer mathematical conclave in the secondary market, the explanatory differentiate explains banks position which suggested to issue the 5Y bond and the 10 Y bond with a shell out centering of respectively 30-35 bp and 60-65 bp. Bonds 5 and 10 long time Years to 2006 Maturity 5 years 10 years Swap Rate (rf) 3,92% 3,98% Min grievous bodily harm Min Max Risk Premium 0,30% 0,35% 0,60% 0,65% Face regard as -100,00 -100,00 -100,00 -100,00 Yield to Maturit y 4,222% 4,272% 4,577% 4,627% coupon Rate 4,125% 4,250% 4, cholecalciferol% 4,625% Price 99,57 99,90 99,39 99,98 Price % 99,57% 99,90% 99,39% 99,98% Fees 0,15% 0,15% 0,25% 0,25% Proceeds 99,42% 99,75% 99,14% 99,73% Cost % 4,256% 4,306% 4,609% 4,659% Table 1 Results for the Bond Issuance Thus, the yield for investors should be the sum of the risk-free and the risk premium rate * Min. 4,222% and max. 4,272% for the 5-year bond * Min. 4,577% and max. 4,627% for the 10-year bond ) The coupon rate The coupon rate is the amount of interest payable on the bond. It is important to keep in mind that the market practices want the yield to vary by steps of 0,125%. Therefore, according to table 1, the yield for the investor varies between 4,125 and 4,250 for a 5-year maturity bond and 4,5% and 4,625% for a 10-year maturity bond. c) The issue price The issue price is the price at which investors buy the bonds in the primary market. The bond issue price is the present value of the bonds cash flow. To obtain this price, we have to use the coupon rate, the face value and the yield for investor as described in this formulaIssue Price = Coupon 1(1+y)+ Coupon 2(1+y)? + +Coupon n1+yn+ Face value1+yn At issuance, the subscriber will pay * Min. 99,57%, Max 99,90% for a maturity of 5-year * Min. 99,39%, Max 99,98% for a maturity of 10-year d) The cost for Belgacom The cost to maturity for the issuer y is defined as Issue Price Fees of the bookrunners = Coupon 1(1+y)+ Coupon 2(1+y)? + +Coupon n1+yn+ Face value1+yn The rate y solving (cost to maturity) this equation is * Min. 4,256%, Max 4,306% for a maturity of 5-year * Min. 4,609%, Max 4,659% for a maturity of 10-year e) Cash Flows Here are the cash flows for the issuer. For a maturity of 5 years At inception (time 0), the issuer receives (99,57%-0,15%)=99,42% multiplied by the total face value. Every year for 5 years, the issuer pays the coupons of 4,125% * face value of the bonds At maturity, the issuer has to repay the whole face value plus the subsist coupon. Cash Flows as % of Face Value 5y-Bond 0 1 2 3 4 5 Bottom 99,42 -4,125 -4,125 -4,125 -4,125 -104,125 Up 99,75 -4,25 -4,25 -4,25 -4,25 -104,25 10y-Bond 0 1 2 3 4 5 6 7 8 9 10Bottom 99,14 -4,50 -4,50 -4,50 -4,50 -4,50 -4,50 -4,50 -4,50 -4,50 -104,50 Up 99,73 -4,63 -4,63 -4,63 -4,63 -4,63 -4,63 -4,63 -4,63 -4,63 -104,63 Question 4 Consider an outstanding corporate bond in the secondary market (issued a few months ago). All else being equal, the market curtly perceives a more important credit risk associated with the considered issuer. What impact should it have on a) The credit facing pages The credit risk is the risk that the issuer may default and not pay back the full amount he owes to bondholders (the total face value of the bonds).The credit spread translates the uncertainty about potential future stock price movements. (Berk, 2011) If the market suddenly perceives more import ant credit risk associated with the issuer, the credit spread will widen as the market is perceived has being relatively safer. The payoff associated to extra credit risk is a higher yield. Therefore, the credit spread represents a bonus for investors when supporting extra risks. Fig 2 Yield curves Source CFA b) The yield There are two components in the yield the risk free rate and the credit spread. All else being equal, if the credit spread widens, the yield increases. ) The price Investors want to pay less for a risky bond having the same pay-offs as a risk-free bond. By taking more risk, the final amount the investor expects to receive may be less than what he will get as there is a credit default risk. (Berk et al. , 2011) The variable on which the market has a direct influence on in order to adjust for a higher yield is the market price. Due to the negative relation between the yield and the price and if the coupon retributions and the principal repayment remain unchanged, th e price must decrease in order to translate the surge in the yield.This is particularly germane(predicate) when the issuer is the target of a leveraged buyout, which, in most cases, is leveraged by the issuance of new bonds. The increased debt used in order to make such financial actions often decrease the totality of the bonds of the issuer to a status of fling bonds. Question 5 How would you assess Belgacoms position with regard to the qualitative factors enumerated to assess the pricing ? * Issue premia for recent transaction First of all, this is the first bond offering issued by Belgacom.Therefore, it cannot be referred to a front premium offered in its own recent transactions. Therefore, the reference will be the telecom peer group having the same risk profile. * After market performance of recently launched deals The issue premia have widened for two main reasons. First, a trend towards more acquisition in the Telecom sector since 2005. Second, the Telecom sector suffers f rom the fact its services are more and more commoditized which in turn may hurt the profitability of a Telecom company. At the time it was expected the bond could be split in three types.A travel rate note and two fixed rate notes. It was expected the 3-year FRN had a spread of 15bp to 20bp whereas the fixed 5-year note would have a 30bp to 35bp spread. Finally the 10-year note would have had a spread of 60bp to 65bp. With regards to recent transactions, Deutsche Telekom was offered a spread of 20bp for a 3-year floating note. 15-20bp is thus potentially better for Belgacom. As far as the fixed notes are concerned, Belgacom seems to benefit for a slightly better spread for 10-year notes but not for the 5-year ones as the one of Deutsche Telekom was only of 17bp in April 2006. Date Swap 5-y Swap 10-y Coupon Spread(bp) Currency Amount Deutsche T April 2006 3. 83% 4% 17 EUR 750m Deutsche T May 2006 4. 13% 4. 75% 62 EUR 500m Telefonica Feb 2006 3. 42% 3. 75% 33 EUR 2250m Telefonica Feb 2006 3. 68% 4. 37% 69 EUR 1750m Vodafone Jun 2006 4. 07% 4. 75% 68 EUR 300m * Are investors liquid? (hedge funds) However, according to the case, investors appetite remained high at that time. In fact, bond issuances remained low because corporates generated increasingly more cash flows and made use of cheaper shipway of funding. Market sentiment? (world, Belgium, politics) There has been a lot of deleveraging followed by acquisitions in the past years. Moodys says the economy of Belgium is only sapless correlated with Belgacoms credit quality. However, for companies that are partly owned by the state, the credit quality of the Sovereign may play a greater role. At that time however, there was no political complications in Belgium yet. In 2006, the subprime crisis had not begun yet either. Hence one could argue the political setting was relatively clear.Moreover, there were strong liberalization policies pushed by the EC and investors were afraid that the Belgian state would disinvest in Belgacom after the following elections. The Belgian state had already to divest, keeping 50,1% of the share. Therefore, investors wanted an insurance policy against a change of control in case the Belgian State sold his participations but also to cover the risk against an LBO. As Belgacom could not introduce a increment wording, it could have had an impact on the credit spread by increasing it. * Credit Spread volatility Credit spread come up significantly more for telecom companies in 2005-2006.This was due to the fact the telecom companies ventured more in acquisition activities during that period. 5-year and 10-year credit spread for A-rated telecom companies respectively rose 10bp and 20bp during that period. * Saturation effect in investors portfolio? Are investors toot of telecom bond issuances? In principle, investors were not sick of telecom bond issuances as the one of Belgacom would add diversification to their portfolio. What is more, Belgacom was seen as a safe and relatively liquid company as they were previously weakly leveraged. * Amount raised in the pastAs far as Belgacom is concerned, the company has never issued any bond. Hence this was a premiere for the company. If we look at the issue amount of comparable transactions in the peer group of the same year, telecom issuers have issued in 2006 from three to 5 times with an issue amount from 500 million. For example, Telefonica issued in 2006 a total of 11. 750 million * Credit quality of issuer and peers In terms of credit quality, Belgacom is better than most competitors. This is mostly due to the fact that Belgacom was weakly leveraged before the issuance.For instance, EBITDA/Interest expenses of France Telecom, Telecom Italia and KPN was between 2. 4x and 7. 2% while Belgacoms was 93x. However, Belgacom wasnt the best according to credit rating agencies. The considered peer group is made of France Telecom, Telecom Italia, KPN and Belgacom. Moreover, Moodys seems to give to Belgacom a better rating that Fitch. Therefore, we may suppose that Belgacoms cost of issuance may be slightly lower than those of his peer group. Question 6 What is a change of control put provision? How would it have protected investors?Why did some investors think the step-up language would not be useful? Looking at the step-up language, what would be the coupon rate if the rating of Belgacom was downgraded a) to BBB- (S&P)/Ba1 (Moodys)? b) to BB+ (SP)/Ba1 (Moodys)? A change of control put provision is an option given to the bondholder to get its bond repaid before maturity at par or above, in the event of change of control followed by a rating downgrade (e. g. after an LBO). Companies may be reluctant to issue bonds including this clause, because it can place more constraints on their finances as investors have the power to control repayments.Besides, it protects investors so they can have the opportunity to change their investment decision strategy if the issuer would happen to change its ownership. In case of a LBO, for example, the ownership of the company is transferred by using debt relying on the future cash flows of the company. According to (Rosenbaum et al. , 2007), a target only represents an attractive LBO opportunity if it can be purchased at a price and utilizing a financing structure that provides sufficient returns with a viable exit strategy. In such a case, a reason bondholder would see the credit risk he faces considerably increase, given the amount of additional debt supported by the company. This clause should then enable a bond investor to exit his position without bearing that increased risk because firstly, the change of control was likely, since the Belgian government was seeking to sell its stake in Belgacom and secondly because some argued that the inclusion of a step-up language taking the form of a +50bp in interest payment per downgrade below investment grade would be far from compensating the additional risk they would be bearing.In the case of Belgacom, there were some concerns about this possible withdrawal of Belgian state from its majority stake, intensified by the fact that the company could also be the target of a potential LBO operation as explained above. In order to reassure prospective investors and consequently lower interest rates for long term bonds (10 years), it has been considered to intromit such a clause in the deal. Therefore, Belgacom finally decided to add a step-up language despite the concerns emitted by some investors.The main benefit of the step-up language is that investors will usually get the initial coupon above the market and will also know what is to expect from their bond(s) over a longer-term period. However, bonds including a step-up language present the disadvantage of being callable by the issuer in order to issue it at lower rate to reduce their cost of borrowing which is the reason why some investors were reluctant concerning the step-up. In the case of Belgacom , a downgrade in the rating would have had the following impact on the coupon rate ) If the rating of Belgacom would have been downgraded to BBB- (S&P) / Ba1 (Moodys) and if the lowest rating is taken into account which is Ba1 (one grade below investment grade), the interest paid (coupon rate) would have increased by +50bp. b) In this scenario, both rating agencies consider a one notch downgrade below investment grade leading therefore to a +50bp increase in the interest rate paid. Bibliography BERK J. , DeMARZO P. (2011) Corporate Finance Global edition Second edition, Pearson edition, pp. 001 FABOZZI F. (1991) The handbook of Fixed Income Securities, Mc Graw-Hill edition, Third edition, p. 224 FAMA E. (1998) Market efficiency, long-term returns, and behavioral finance Journal of financial Economics, 49, pp. 283-306 GLAZER A. (1989) Acquisition bridge financing by investment banks bridge financing, as source of revenue for investment bankers, poses risk and conflict of interest Business Horizons magazine, Sep-Oc 1989, Website http//findarticles. om/p/articles/mi_m1038/is_n5_v32/ai_8120675/ (Seen in April 2012) ROSENBAUM J. , PEARL J. (2009) Investment Banking Valuation, Leveraged Buyouts and Mergers Acquisitions Wiley finance Vodafone Non Official Website www. vodafonews. com/belgique. html (Seen in April 2012) 1 . www. vodafonews. com/belgique. html 2 . Exhibit 13