Mergers and acquisitions are littered with content the average investor may struggle to understand. And the 2015 Mediclinic reverse takeover of UAE-based Al Noor hospitals is no different. The deal created one of the largest private healthcare providers in Europe, the Middle East and Africa. But it’s the area of funding where the interest lies. Remgro was a 41.9 percent stakeholder in Mediclinic and initially funded its part of the deal with a ÂŁ600 million transaction using existing cash resources and a short-term bridging facility. A portion of the bridge was refinanced using an exchangeable bond, which was the first ever issued by a South African issuer. Alec Hogg sat down with RMB’s Dale Wood to get a deeper understanding of the transaction, in essence the nuts and bolts of the deal. – Stuart Lowman
This special podcast is brought to you by RMB, whose Dale Wood, Head of Debt Capital Markets, joins us now. Remgro is one of your clients. Maybe we can go through very briefly the process of why or how Remgro, once identifying the fact that it wanted to globalise Mediclinic, started putting the building blocks in place.
Mediclinic has had international operations for some time and is constantly evaluating opportunities to expand their footprint in target jurisdictions, Switzerland being one, and the Middle East another. The Mediclinic team identified Al Noor, which was an excellent acquisition opportunity.
Because Al Noor is a bigger company than Mediclinic, and Remgro did not want to dilute its shareholding, Remgro needed to make an acquisition of some of the shares in Al Noor as part of the overall transaction, so that post the merger Remgro would have a slightly higher shareholding than it originally had in Mediclinic. In order to do that, and to meet the timelines required to do that, they couldnât go through a lengthy process of raising capital in the capital markets. RMB and our joint venture partner, Morgan Stanley, provided some considerable bridge funding in the form of hard currency Pound funding. The transaction then went ahead and Remgro was then in the position of needing to refinance the bridges. You may recall that this coincided with Nenegate at the time, which certainly put a different spin on how we could possibly refinance some of those positions.
What was the timing of all of this, when you say it was around the time of Nenegate?
The acquisition was going through and the bridge financing was extended in the second and third quarter of last year. We had already started doing a considerable amount with the take out of the bridges. It obviously all happened behind the scenes, because it was fairly price sensitive and confidential information we worked with. We were already very well advanced with the take out structure for the bridges and Nenegate happened at the backend of November.
Sorry, Dale just to understand this when you say âthe bridgesâ⌠In essence, Remgro supported Mediclinic to do this big transaction. It needed to give it Pound funding to do that, a dollop of cash as it were, which you provided with your joint venture partner, Morgan Stanley, but then you needed to restructure all of those fundings. Have I got it right there?
Correct, so the bridge funding is very much acquisition related and itâs very much a short-term debt facility that provides the capital required to enable the deal to happen. That short-term debt funding doesnât represent the optimal capital structure for Remgro or for the group going forward. That needs to be refinanced and usually we try to refinance it in a shorter period of time because through a more appropriate mix of debt instruments you can typically achieve a better cost of funding for the growth.
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Yes, I think we can all understand that. If you need something urgently you perhaps take an overdraft but then find a different way of structuring the repayment thereof. Youâve come up with a very innovative and in fact, first ever for any South African company. What you call an exchangeable bond for a big part of the bridging finance.
Correct, yes. An exchangeable bond is not new internationally, although itâs not that common in South Africa. It really is just a variation on what we typically call a convertible bond. It is a debt instrument that has an option attached to it, giving the holder of the debt instrument the right to convert that debt instrument into shares if the share price runs through a specified strike price. In Remgroâs case, Remgro has issued a bond, but the bond is exchangeable into Mediclinic shares.
Another variation on an instrument, just by way of background I remember there used to be many convertible debentures around. This is clearly not a debenture. It is something different.
Yes, I suppose in that it is a debt instrument that can be converted. It is similar in principle but given the tenor and the terms of it, itâs a five-year instrument and the rights and obligations and where it ranks in the capital structure of the issuer. It does make it different to what convertible debentures would typically have been used for but certainly in theory or concept â fairly similar.
So this exchangeable bond is issued by Remgro because Remgro borrowed the money in the first place to help the deal to go ahead and had Mediclinic itself been borrowing would the interest rates have been any different to this seemingly very attractive rate that Remgro has managed to get on this bond?
Yes. Remgro and Mediclinic obviously have different credit ratings and as separate entities, would be able to lend or borrow at different rates. What Remgro has effectively done though is Remgro has reduced the cash cost of its own borrowing rates by monetising the value of the volatility in the Mediclinic shares. As the Mediclinic shares trade, they move up and down on any given day and that volatility gives any option value and the value of that option embedded in the bond reduces the coupon that gets paid on the bond. Remgro has effectively monetised the underlying volatility in one of its investments to achieve a lower cost of funding.
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How much would the difference be?
Typically, it can be anywhere from 1.5% to 3%, probably about 2% in this case.
And your Remgro will be paying 2.625% on this five-year bond, so clearly youâre talking probably… Had it just borrowed the money without being able to exchange it into Mediclinic shares it could be 4.5% or even 5%.
Correct and just to clarify when we talk about borrowing and that pricing. Thatâs in the form of a bond in the international capital markets, so Remgro in the local South African market could certainly fund itself through debt funding, significantly cheaper than that, but if one was looking at the rates that they would have to pay it on offshore vanilla bond issued to international investors. That would be significantly higher than what they can fund in South Africa, so probably 3.5% to 4%, at that time. I think spreads have tightened considerably since when we launched this, so they could probably be looking at tighter pricing since then, but certainly theyâve saved themselves considerable cash flow through an exchangeable rather than a vanilla bond.
Yes, and it is a listed instrument?
It is. Theyâve listed in Frankfurt. It trades on the Frankfurt Stock Exchange and itâs mostly an institutional following of asset managers who buy and sell the instruments, but it is certainly open to the public and retail investors are able to trade in. I think the minimum trading size, which is governed in terms of the EU regulations, is probably prohibitive for most men in the street. I stand to be corrected but I think ÂŁ10,000.00 is the minimum tradable size, so that does knock out the ability for a number of people to participate as individuals.
Dale, it is priced in Pounds. Why then go to Frankfurt?
In any issuance internationally weâll always advise our clients which exchange is most appropriate, but typically weâll be evaluating, usually in Frankfurt, Ireland or the LSE (London). Depending on market conditions, the objects of the deal, the issuer there may be one reason or another why one exchange is slightly better than another exchange, so unlike South Africa where if youâre issuing in Rands, the JSE really is your only real option. Overseas there are a couple of different exchanges and weâll evaluate deal by deal, which one makes more sense for the transaction.
Did Brexit have anything to do with your decision?
Brexit didnât have anything to do with the exchange we chose but it definitely did influence the timing of the launch. At one stage when we were considering whether we should launch the deal before the Brexit vote or wait .
So the timing was good?
It was good and weâre very happy that we went with that choice. I think weâd be in a very different position if we had waited.
I guess primarily, because after Nenegate South African institutions didnât really have the capacity to support this kind of issue.
No, thatâs correct. So unfortunately with the Rand blowing out the way it did, it pushed virtually all of the asset managers in South Africa over their foreign exchange allowances and thereâs a lot of pressure on them to manage that and to show the Reserve Bank that theyâre managing that. When we marketed the deal we talked to most of the major asset managers. All of them liked the instrument and all of them were very keen to participate, but because it was Pound denominated and would count against the offshore allowances, none of them were able to come in. I think we ended up with one or two orders of very small size. Ultimately the whole deal was carried by the international investors.
But presumably now that the Rand has improved it might allow them to buy these bonds on the Frankfurt Stock Exchange.
I think so. Certainly we have seen some âlook-insâ. What also happened post-issue is, through financial institutions such as RMB and some of the other banks, we were able to actually help synthetically convert the offshore exposure into a Rand exposure and sell that onto the asset managers, where we almost acted as an intermediary and were able to pass on the instrument, but in a Rand form. That all goes on as part of normal market trading and part of the structuring work that we do.
Just as part of the details, you did say that because it is convertible bond into Mediclinic shares Remgro would pay less. What are the conversion terms?
The conversion terms of this are at a 30% premium through the share price of Mediclinic, at the time of issue. So as issued the Mediclinic share price in London was ÂŁ8.79 and that gives you a conversion premium then of ÂŁ11.31 itâs actually 11.3086, so effectively what that means is that as the Mediclinic share price trades above 11.31, any holder of that instrument now has an âin the money optionâ and they would be able to effectively convert the bond into shares at a strike price of 11.31. If the share was trading at 12 that, in effect, is making a 70 Pence profit per share on that.
What we typically see though is that investors will hold onto the instrument right up until maturity because you maximise the option value by waiting until maturity, rather than converting earlier.
So if you wanted to, if you had some particular reason for doing so, the minute that the shares rise above, in this case ÂŁ11.31, you could trigger it, but would you, if you were so inclined and wanted a big chunk of shares today would you be able to trigger it even though the share price is trading below that level?
You could. It wouldnât really make economic sense, as you pointed out because obviously youâd be buying at a higher price, when you could be buying in the market at a lower price. But thereâs nothing to stop you calling to convert sooner. Built into the terms is a short closed period, which we call a âno call periodâ which enables you to, once youâre through that period, to convert it any time you want.
So itâs a five-year term. Presumably anybody buying into this company or buying these bonds would think that the Mediclinic share price will appreciate by more than 30% in five years, hence the benefit.
Yes, that is certainly the thinking behind it and thatâs also part of the thinking why we have a cash settlement option built into the instrument. What I mean by that is that Remgro has the ability to settle on conversion, either in Mediclinic shares or in cash, to the same value of those shares. The reason theyâve done that is because Remgro may decide that they want to hold onto the physical shares and they certainly expect the share performance will be at least that, if not better, so it gives them the option to retain the shares and simply settle in cash.
How do you come to a figure of 30%? What kind of other drivers come into that conversation?
Normally the conversion premium is somewhere between 30 and 35. Itâs not that we start with that, but it just seems to be that thatâs where the mass normally ends up. If you have a conversion premium or a strike price lower than 30%, you obviously have far more chance of being in the money on your option, so your option becomes more and more valuable, which has the impact of reducing your coupon. But at some point, if you set your strike price so low, letâs say at a 5% premium, the instrument for all intents and purposes may as well be an equity instrument, because your conversion price is so close to your issue price, that youâre actually giving away a huge amount of equity value. Similarly, if you set it way above 35%, letâs say 50% to 60%, again, the chances of your option then being in the money start becoming so remote that you actually donât really get any benefits, in terms of your coupon cash saving. The maths we do is to create various scenario analysis to work out at what point you are getting the maximum saving on your coupon, but not giving too much equity value by setting your conversion price too low.
And the market would show you, by the support or not.
Thatâs exactly right. When we launch the instrument weâll say we believe that the appropriate conversion premium is somewhere between, letâs say 28 and 33. In this case we actually launched with the range saying conversion premiums were 30 to 35 as part of the auction process to the market. We built a book, and asset managers put in orders. As part of the orders they actually say where they see the conversion premium, and theyâll be putting in a premium somewhere between 30 and 35. Itâs part of our job to then almost clear that or come up with the one number that achieves the companyâs objectives, but also use the clearing price at which the market has determined the price effectively. In the case of Remgro that was 30%.
ÂŁ350m is big money when you bring it into South African Rands. On an international stage though is it a significantly large issue?
Itâs significant. It is certainly above what we refer to as a benchmark size. Sometimes you would hear a bank talk about a benchmark bond issuance. What that really means is that above a certain size international asset managers start paying attention because the instrument will be included in some or other index. Given that most asset managers have to at least track, if not beat an index, thereâs a huge incentive on them to buy into that instrument because they know that it will be included in the index if it is over a certain size. Now, there is no hard and fast rule, but typically around ÂŁ250.00 to ÂŁ300.00 is considered to be a benchmark size. So thatâs the kind of size that you would expect the instrument to be included in an index, and asset managers are now incentivised to participate in the deal. We actually launched at 300, and then because of demand, we upsized to 350, so it is definitely a sizeable, benchmark deal. It will be included in various indexes but it is certainly, by no means anywhere near the one billion Pound type issuances from some of the international global companies.
You see, youâre giving away the numbers that you deal with, when you talk about 300 â its ÂŁ300m of course, and not just ÂŁ300.
Yes.
Dale, what kind of investors did you get in, given that very few South Africans were able to support you?
A very good spread of international investors, similar to the ones you would expect to be in South Africa. The international equivalents of your Coronations and Allan Grays, we got a good mix of hedge funds, long only investors, guys who are going to be trading in and out of it regularly, as well as guys who are actually going to buy it and hold it for the long term. Names that you could expect to see in there, the likes of Black Rock, a high bridge myriad capital. Many of the big, international and well-established asset managers.
Howâs the instrument done since the listing?
Itâs traded very well. Thereâs good liquidity in the instrument. I had a quick check earlier today, so given that the Mediclinic share price is currently trading at about ÂŁ10.80, itâs starting to trade quite close to the conversion price already. The Remgro bonds are actually trading at a premium of 12%, nearly 13% premium to par value. Itâs basically traded up very strongly since the issue. Itâs been very well received. Investor feedback has been very good and the company is very happy with it.
