Peripherals tipped to join hybrid party but fundamentals niggle

* TKA first sub-IG euro hybrid since January 2011

* Peripheral corporates ideal candidates as austerity bites

* Spread widening on senior peripheral bonds sparks caution

By Josie Cox

LONDON, Jan 28 (IFR) - Telekom Austria's blowout hybrid deal, six-times subscribed despite its low ratings, could tempt even peripheral corporates to try their luck with the instrument, bankers say.

The EUR600m bond did carry one investment-grade rating, Baa3 from Moody's, but is BB+ with S&P, making it the lowest rated euro hybrid since Danish oil and gas group Dong's EUR700m offering in January 2011, which carried the exact same ratings.

Investors' hunt for yield first revived the high-grade core European hybrid market, and then made the instrument available to corporates further down the ratings spectrum.

Telekom Austria garnered EUR9bn in orders and followed Veolia's dual-tranche sterling and euro hybrid that was rated one notch above junk by Moody's and S&P and attracted combined books of EUR9bn in the first week of January.

So far this year, EUR4.25bn, USD3bn and GBP165m of hybrid securities have been placed in the European market, and the next step, bankers are saying, is for a break into peripheral Europe.

Antoine Loudenot, head of capital structuring at Societe Generale, said that for many companies it would be an ideal way to buffer their balance sheets in the face of adverse macroeconomic factors.

SHAREHOLDER IS KING

Many companies in the eurozone's periphery have been battered by austerity measures, dwindling consumer spending and tax hikes. Some, like Telefonica, have towering debt piles to refinance, and while issuing senior bonds is still a cheap method of raising funds, hybrids are one way of doing so without upsetting the debt-to-equity balance, thus protecting credit ratings.

At 6.781%, Telekom Austria's dividend yield is significantly higher than the 5.625% coupon offered on its hybrids, and another benefit is that debt is tax-deductible and does not dilute shareholders.

For a company like Telecom Italia, which has seen the value of its stock slump by 10% year-to-date, Iberdrola, which has witnessed a decline of 6%, or Telefonica, whose shares have plummeted almost 18%, prioritising shareholders' interests is paramount.

Sectors that have traditionally lent themselves to the hybrid structures include telecommunications and utilities which benefit from high cashflows.

A note published last week by Fitch forecast that the telecommunications sector may be one of the very few to witness an increase in capex this year, countering a broader trend toward cash preservation elsewhere.

Fitch said this could be driven by intensifying competition, forcing operators to increase spending on 4G spectrum auctions.

FUNDAMENTALLY PROBLEMATIC

The problem is that the Italian, Spanish and Portuguese corporate bonds priced in recent weeks have hardly performed strongly, raising the question of whether investors really are ready to accept any additional risk.

Telefonica's January 2023 offering that priced during the first week of the year has widened by 26bp, and Gas Natural's January 2023 bond has widened by around 10bp. Both companies are rated Baa2/BBB.

EDF's four-tranche three-currency hybrid attracted a combined book of around EUR21bn-equivalent for a total transaction size of around EUR6bn, but as EDF is majority owned by the French state, it is one of the lowest-risk hybrids the market has seen in several years.

Whether a peripheral bond would be able to generate demand of this scale, or even close, is still questionable. (Reporting by Josie Cox; editing by Alex Chambers, Julian Baker)