M&A and Investment Banking

M&A and Investment Banking Lecture 8 – DCM - ECM and Rights Issues

Potential Financing Alternatives for Corporate Debt Equity Credit Spectrum Equity Straight Debt: Bonds and Loans Convert w/call spread overlay Convertible Bond Equity Capital Increase Structure Bonds • All major markets open in size – US$, Euro and £ • Public transaction • Benchmark maturities of 3–12 years in Euro, out to 30-years+ in US$ and £ Loans • Private transactions • Five year convertible bond • Longer maturities possible • Conversion premium of 32–37% • Sale and purchase of call options structure to achieve 60%+ premium • Annual cost saving relative to straight debt rate • Option premium on upper strike treated as equity for accounting and rating agencies • Five year convertible bond • Longer maturities possible • Conversion premium of 32–37% • Cash coupon: 2.375–2.875% (assuming current dividends) • Full amount would be treated as debt by rating agencies • Option component would be treated as equity for accounting purposes • Capital increase with or without pre-emptive right • Could include a roadshow • Typically priced at a discount to the market price Advantages and potential issues • Non-dilutive • Tax deductible • No equity credit given by rating agencies • Good demand across markets • Issuance windows will continue to be somewhat volatile • Issuance dependant on market sentiment at the time of issuance • Low cash coupon vs. straight debt • Lower EPS dilution than a traditional convertible bond • Potential sale of shares at premium to the current share price • Option premium on upper strike treated as equity by rating agencies • The IB will be a buyer of the issuers shares on the day of the convertible offering, minimising potential share price impact • Lower proceeds raised vs. a traditional convertible bond, hence higher all-in-cost • Low cash coupon vs. straight debt • Can be structured to minimise EPS impact • No equity credit given by rating agencies • Potential temporary negative share price impact, but less than with equity or mandatory convertible issues • Full equity credit With pre-emptive rights • Not dilutive for existing shareholders if they exercise their rights • Allow existing shareholders to benefit from potential upside following M&A • Possibly large discount • Longer process and execution Excluding pre-emptive rights • Leaner and shorter process • Some execution risk Market receptivity • Market is open for issuance • Market is open for issuance • Market is open for issuance Structuring solutions to enhance yield and manage risk Investment Strategies • Yield enhancement • Hedged investments Hedging Strategies • Financing and volatility • Complex assets • Illiquid assets Capital Management • Return of capital • ESOP • Liability management (e.g. convertible restructuring) • Monetisation Special Situations • Income repatriation • Income management • Tax risks / claims

ECM and DCM Debt Capital Markets

Debt Capital Markets • Debt Financing for Corporations • DCM Deal Structure and Types of Transaction • Credit Rating

Debt Capital Markets role with Corporate Debt Capital Markets Loan/Bond Financing Hybrids/Convertibles/ Private Placements Capital Structure – Ratings Advisory M&A Risk Management - Contingent Hedging Finance Department Daily Decisions FX/Interest Rate Management Tax Pensions Cash Management

Credit Ratings Categories • Rating is a “risk category” assigned by objective ratings agencies to corporate, sovereigns and specific issuances • They represent the relative degree of credit risk • Leverage (i.e. debt) is a key factor in determining the credit risk Long-term Rating Symbols Moody’sS&P / Fitch Risk of P&I Not Being Paid When Due AaaAAA Extremely low risk of default AaAA Very low risk A A Low risk Baa BBB Moderate risk Ba BB Moderately speculative B B Highly speculative Caa CCC Very high risk Ca, C CC, C Highest risk - D Default (agency definition) Investment Grade(high grade) Lowest DefaultRates Highest Non-Investment Grade(high yield; “junk”)

Straight Debt - Deal Structure Currency • Major funding currencies – USD, EUR, STG, CHF • Arbitrage funding – AUD, NOK, CAD, NZD • Considerations: • All-in cost of funding – comparison of levels swapped back into funding currency • Investor diversification vs. absolute funding costs Maturity • Currency • STG/USD – strong investor appetite for long-dated securities • EUR/CHF – rarely see issuance beyond 12/15yrs • Issuer’s outstanding maturity profile • Funding needs – cash flow generative consumer company compared vs.utility with long-term assets to fund • Depth of investor demand – investors looking for longer-dated assets in the current low yield environment • Shape of the curve Fixed vs. Floating • Fixed rate - typically offers the deepest investor base and access across the curve • Key accounts: Asset Managers, Private Banks, Insurance/Pension Funds, Hedge Funds • Floating rate investors – typically shorter-dated maturities with focus on financial issuers given buyer base • Key accounts: Bank Treasuries, Money market funds • Interest Rate Expectations

An Example - Telecom Italia GroupEuro Medium Term Note Programme by €20bn for issuances on the Euromarket

Telecom Italia Rating Profile Source: Bloomberg as of 2 September 2013

An Example - Telecom Italia GroupNotes issued by Telecom Italia SpA(2) and Telecom Italia Finance SA(3) (1) Source: http://www.telecomitalia.com/tit/en/investors/bondholders/telecom_italia.html; http://www.telecomitalia.com/tit/en/investors/bondholders/ti_finance.html Notes: (1) Outstanding amount (in the case of convertible, posted at redemption price). (2) Updated on June 2013 (3) Updated on February 2012

Straight Debt - Main Types of Transaction Best Efforts Basis • The issuer is taking the risk of execution of final terms • Lead managers receive a flat fee – may be some additional incentive fee based on meeting specific goals • Issuer considerations: • Execution capabilities and distribution • Lending and client relationship Underwritten Bond / Backstop • Underwrite/”Bought Deal” – typically the Investment Bank buys the bond at a pre agreed level and the bank’s profit is based on its ability to distribute the bond through the underwrite level • Backstop – The Investment Bank provides issuers with a backstop level at which they have certainty on price. Typically the Investment Bankis paid a pre-agreed fee retaining the upside potential • Issuer considerations: • Ultimate pricing terms available • Execution capabilities and distribution – a badly placed bond can have long-term implications on issuer’s access to the market

ECM and DCM Equity Capital Markets

Equity Capital Markets • ECM Role in an Investment Bank • Product Range • Execution Strategies

ECM Role in an Investment Bank • Equity Capital Markets sits between issuers and investors and as such, is the conduit that facilitates dialogue and activity between our corporate and institutional clients • ECM sits on top of the Chinese wall - receiving information from both sides of the wall • Extensive information on investor behavior and preferences and interest from sales and research with flow of capital information coming from the trading side Chinese Wall Research Corporate Clients Equity Capital Markets Sales Investors Investment Banking Trading

ECM Product Range IPO Follow-on Offerings Equity-linked Securities Derivative Transactions Description • Sale of private company to institutional investors • No existing reference price • Valuation methodology and research credibility are key in the preparation process • Marketing strategy including pre-marketing and roadshow • Sale of shares to investors (including capital increases) • Stock already listed and traded on a recognised stock exchange • Simpler pricing decision due to existence of reference price • Marketing strategies range from salesforce briefing to complete pre-marketing and roadshow • Sale of securities is contingent and linked to a fixed income or preferred security • Highly tailored and structured solutions (refinancing, disposals etc.) • Marketing period between 1 day and 2 weeks in length • Structured products used to hedge or dispose of stakes discreetly • Tailor-made solutions with material tax advantages possible • Only possible on listed stock • Private transactions away from the market place Examples

Cash Equity Financing Alternatives Rights Issue Fully Marketed Capital Increase Accelerated Capital Increase Description • Offering of Company’s shares at fixed price (at or at a discount to market share price) with pre-emptive rights for existing shareholders • Offering of Company’s shares via open priced bookbuild (non pre-emptive) over up to 2 weeks, with marketing roadshow • Issue of Company’s shares through an undocumented, rapidly bookbuilt offering without marketing • Simplest and most rapid execution (up to 2 days but usually completed in 24 hours) • Very limited transaction documentation (no offering document) • Very limited involvement of the Company management • Possibility for core shareholders to participate through order book Advantages • Avoids ownership dilution for existing shareholders, if required • Opportunity to convey renewed equity story to new and existing investors • Rights issues for acquisition financing well-received by investors • Platform to maximise size • Maximum demand generation / price tension • Opportunity to convey renewed equity story to new and existing investors • Potential retail participation Considerations • More complicated and lengthy process • Prospectus and other transaction documentation – extended preparation • Longer exposure to market • Vendor carries price risk during bookbuilding • Prospectus and other transaction documentation – extended preparation (typically less than in rights issue) • Longer exposure to market • Vendor carries price risk during bookbuilding • Reduced investor penetration relative to Fully Marketed Offer • No opportunity to convey equity story and acquisition rationale • No retail participation Timing / Execution • Execution: approx. 3 months • Offer period: minimum 5 – 20 business days • Execution: approx. 2-3 months • Offer period: approx 10 business days • Flexible, execution within 2 weeks Documentation • Prospectus • Prospectus • Undocumented transaction based on a placement agreement Size • Significant size achievable (also as % of existing share capital) • Significant size achievable (also as % of existing share capital) • Significant size achievable, but potentially lower than in rights issue / fully marketed placement

Monetization Strategies Accelerated Bookbuilding Block Trade Fully Marketed Offer Optional Exchangeable Mandatory Exchangeable Structure • Open-priced bookbuild • Pricing at or close to market at end of bookbuild • Broad distribution targeted • Can be backstopped (or executed through multiple placings for larger size) • Sale at fixed net price to bank • Discount to prevailing price reflects transfer of risk • Immediate re-offer to investors • Competitive auction possible • Open priced bookbuild over up to 2 weeks • Intensive management roadshow • Pricing at or close to market at end of bookbuild • Broadest distribution targeted • Potential to include retail • Debt with embedded call options over underlying shares • Exchangeable which mandatory exchanges into shares at maturity • Equates to a forward sale of equity where the issuer benefits from some of the subsequent share price upside Pros • Combined offering with ABB creates price tension between equity and equity-linked offering • Positive signal to the market • Guaranteed disposal at a potential premium to current share price • Eliminates downside risk on the underlying shares while allowing to retain partial upside • Takes advantage of low volatility levels • Market capacity up to full size • Achieves significant size • Minimisesmarket exposure • Good price tension and deal momentum • Simple documentation and quick access to market • Minimal disruption for management • Should price at or close to market • Certainty of execution • Elimination of market risk • Reduces scope for institutional positioning • Transparent and verifiable process • Simple documentation • Minimal disruption for management • Platform to maximise size • Maximum demand generation, price tension • Achieves highest price in stable or rising markets • Vendor leverages removal of near-term overhang • Broadest universe of investors • Benefits from management marketing • Creates very high profile liquidity event • Combined offering with ABB creates price tension between equity and equity-linked offering • Positive signal to the market • Potential sale of shares at a premium to the current share price • Low coupon • Market capacity up to full size Cons • Vendor carries price risk during bookbuilding (unless backstopped) • Banks still charge for taking risk in stable market • No upside for vendor in rising market • Fastest possible, narrow distribution can damage aftermarket and perception of deal success • No benefit from bookbuilding process • Vendor carries price risk during bookbuilding • Historically scope for institutional position taking during execution • No certainty of disposal of underlying shares • Results in market to market of the short call option • Higher coupon payments (tax deductible) • Upside participation limited above the upper call strike (market is however receptive to mandatory structures with higher call strikes)

Equity-linked Products Capital management Capital raising Employee share schemes Mergers & acquisitions-related • Stock option plans • Convertible / exchangeable restructuring • Equity-linked securities liability management • Contingent capital • Convertible securities • Hybrid convertibles • Mandatory convertibles • Leveraged employee share ownership plans (LESOP) • Option plan tax optimisation • Strategic stake-building • Contingent value rights / certificat de valeur garantie (CVR / CVG) • Maintenance of free-float Monetisation Share financing Structuring • Gamma / volatility trades • Delta trades • Exchangeable securities • Synthetic exchangeables • Mandatory exchangeables • Gap risk trades / margin loans • Swaps • Share repurchase (repo) • Tax • Accounting • Private Bank

ECM and DCM Rights Issues

Rights Issues • Definition & Terminology • Discounts & Dilution • Value & Trading

What is a Rights Issue? • Pre-emptive offering of new shares to all existing shareholders • Rights provide shareholders the right but not the obligation to subscribe for new shares • Cash payment for subscription • Fixed price (issue/subscription price) and ratio (new: Existing shares) • Rights tradable/sellable • By both existing and new investors • Relatively practical source of funds for issuers in 2008/2009 • Recent changes in rights issue timetables and guidelines to facilitate execution • Typically underwritten • Well understood by market • Take-up % often binary and usually 90–95% A rights issue is a method by which a company can execute an equity capital increase through the pre-emptive issue of rights to existing shareholders allowing them to subscribe for new shares pro rata to their existing holdings

Rights Issue – Terminology Issue price • The price at which shareholders can acquire new shares in the rights issue Gross discount • The discount between the closing share price pre-announcement of the rights issue and the offer price Nil Paid Rights (“NPRs”) • The rights that a shareholder is given to acquire new shares at the offer price. These are traded on the Stock Exchange alongside the ordinary shares Pricing Theoretical Ex-Rights Price (“TERP”) • The theoretical price per share immediately following the issue of the nil paid rights Discount to TERP • The discount between the theoretical ex-rights price, or TERP, and the issue price

Rights Issue – Terminology (Cont’d) Ex-rights Date • The day after which, the ordinary shares are declared “ex-rights” and the nil-paid rights begin to trade on the Stock Exchange Rights Trading Period • The period during which rights can be traded as a separate security Timetable / Process Subscription Period • The period during which right-holders can exercise their rights to subscribe for a new share at the issue price Rump Placing • Sale of shares not subscribed for by shareholders. Takes place after the end of the subscription period. Proceeds of the rump placing are remitted to shareholders Tail Swallowing • The process by which a shareholder sells sufficient nil-paid rights in order to subscribe to the balance of their available rights, without investing additional funds. In the case of company directors, this sends a more positive signal to the market vs. no exercise at all Shareholder Behaviour “Lazy” shareholder • A shareholder who does not subscribe for or sell his / her nil-paid rights during the subscription period. Those rights are sold in the market in the “rump placing”, at the end of the subscription period, with proceeds over the subscription price being passed on to those lazy shareholders

Rights Issue – Discount • The gross discount represents the discount of the subscription price to the market price pre-announcement • The discount to TERP represents the discount of the subscription price to the price at which shares should theoretically trade upon launch of the rights offering when shares are ex-rights • The theoretical ex-rights price (TERP) represents a weighted average price of the existing shares and the new shares • From an arithmetical point of view it can be expressed as follows: Cum-rights share price X Pre-issue # of shares + Subscription price X New # of shares issued (i.e. pre-issue market cap) (i.e. rights issue proceeds) Pre-issue # of shares + New # of shares issued (i.e. total # of shares outstanding post-issue) TERP =

Rights Issue – Discount (Cont’d) Example =(Subscription Price (€) / Share Price (€))-1 =(6.25/10)-1 =Rights Offering Size (€) / Subscription Price (€) =500/6.25 =New Shares Offered / Shares Outstanding =80/100 =New Shares Offered + Shares Outstanding =80+100 =((New Shares Offered * Suscription Price) + (Shares Outstanding* Share Price))/(Pro-Forma Shares) =(80*6.25+100*10)/(180) =(TERP (€) / Share Price (€)) -1 =8.33/10-1

Rights Issue – EPS Impact • On a EPS basis, rights issue are usually dilutive • Dilution will depend upon: 1) the return expected on the capital raised and 2) the number of new shares to be issued, mainly affected by: • Rights issue size • Gross discount to share price • Illustrative example: Note: (1) Assumes capital employed at 2% after-tax return.

Rights Issue – Value and Trading Rights trading – worked examples • Rights received to subscribe for new shares at a discount have an intrinsic value, calculated as: • Difference between the ex-rights price and the subscription price times subscription (i.e. rights) ratio • The investment required by a non-shareholder for a given percentage holding is fixed and does not depend on the discount to TERP • Buy new shares at the ex-rights price • Buy rights in market and subscribe for new shares at subscription price • Rights trade like shares on exchange throughout the rights trading period • Rights trading is inherently more volatile than share trading due to the multiplier impact and sensitivity to share price changes • Investors can arbitrage between the right and the share = (Ex-rights price – Sub price)* Subscription Ratio =(8.33-6.25)*(0.8) = (Share Price – Sub Price) * Subscription Ratio =(7.5-6.25)*(0.8) = Sub Price + Rights Price / Subscription Ratio =6.25+(0.9/0.8) =(Current Share Price / Share Price Implied by Current Rights Price) – 1 =7.5/7.375 – 1

Issues Driving Rights Issue Pricing What Drives the Rights Issue Discount? Highdiscount Higher Larger High Long Issues Weak Lower Market Conditions Expected take-up Incentive to Subscribe IssueSize(1) Volatility Risk Period EquityStory Cleanslate Lowdiscount Lower Smaller Low Short Strong Higher Does the discount matter? • A rights issue at a discount is equivalent to an issue at at-market price plus a ‘bonus’ issue (for zero consideration) of new shares • Reflected in accounting conventions – historic price, EPS and DPS adjusted to reflect the ‘bonus factor’ (i.e. # of new shares issued as a bonus to existing shareholders = TERP/share price) • Adjustments made mechanically by analysts, data providers (Bloomberg, Reuters), etc • The rights offering discount does not, by itself, cause: • Loss of value for issuer • Higher dilution for company shareholders • Lower multiple for issuer post offer • But mechanical adjustments do not fully capture the significance of the discount • The messaging impact of the discount itself (a tight discount is sometimes perceived as reflecting confidence in the issue) • Market’s perception of value creation (i.e. accretion / dilution) achieved through investment of rights proceeds Setting the right price is key to determining the success of the rights issue. Rights issues where the stock trades at or near the subscription price for an extended period of time have low take-ups Note: (1) As a % of existing market cap – i.e. rights issue ratio and as multiple of Average Daily Volume.

Convertible Bond Refresher Description Economic Flows At issue At issue • Bond nominal: €1,000 • Share price at issue: €20.0 • Conversion premium: 25% • Conversion price: €25.0 (= €20.0 x (1+25%)) • Conversion ratio: 40.0 (=Notional / Conversion pr.) When does an Investor convert her/his bond? • If the share price at maturity is €30, the value of the shares is €1,200→ the Investor will convert • If the share price at maturity is €10, the value of the shares is €400.0→ the Investor will not convert and Issuer has to redeem €1,000 Convertible Bonds Issuer Investors Issue Proceeds During the life Issuer Investors Coupon Payments Upon conversion Convertible Bonds Issuer Investors Underlying Shares At maturity if no conversion Issuer Investors Issue Proceeds • On a EPS basis, dilution will depend upon: 1) the net after-tax cost of the convertible (return on proceeds – coupon), 2) the number of new shares to be issued, mainly affected by the conversion ratio • If the convertible bond has mandatory features, upon crossing of the conversion price, the bond will automatically convert into new shares A convertible bond is a bond where the holder has the option to convert its bond into a pre-determined number of shares

Comparative Cost of Financing Relative Cost of Capital Analysis as a Function of the Share Price at Maturity Equity Convertible Cost of funding Debt If not converted, instrument provides cheap funding If converted, equity sold at a premium to stock price at issue Debt is Cheapest Equity is Cheapest Convertible is Cheapest Share price at maturity

References • Fleuriet, 2008. Investment banking explained, McGraw-Hill: chapters 10 - 13 • Liaw, 2011. The Business of Investment Banking: A Comprehensive Overview, Wiley: chapter 8, 9

M&A and Investment Banking