March 21, 2013 / 8:05 PM / in 5 years

US Steel extends near-term maturities

NEW YORK, March 21 (IFR) - United States Steel rolled its maturity stack last week with a two-part sale of evenly-sized convertible bonds (CBs) and high-yield debt.

As a well known issuer in both markets, the steelmaker aimed and achieved pin-point pricing on the financing, which helps pre-fund the US$862.5m of 4% CBs that come due next May.

The CB, which was structured as a six-year security with four years of call protection, was targeted toward outright investors from the outset.

Such an orientation and the crowding out of technical buyers is not dissimilar to other recent new issues but was even more pronounced in this instance, highlighting the high costs of hedging out both equity and credit risk.

JP Morgan, Barclays, Goldman Sachs and Morgan Stanley launched a one-day bookbuild Wednesday morning on a US$250m CB against price talk of 2.5%-3% and 27.5%-32.5% on the coupon and conversion premium, respectively.

The concurrent US$250m eight-year non-call four bonds were talked in the range of 6.75%-6.875%, providing a credit benchmark.

The marketing effort ended with the company pricing an upsized US$275m CB at 2.75% and 30%, and US$275m of high-yield bonds at 6.875%.

The deal is significant in several ways.

Pricing of the high-yield bond provided a benchmark credit for the CB, not atypical on such dual-tranche transactions.

What was unusual is that the cost of hedging credit risk via credit default swaps is materially higher than what was implied on the high-yield bonds.

The costs of shorting the company’s equity are also prohibitively expensive. As of February 28 there were 36.9m US Steel shares on loan, roughly 25% of the company’s float and equal to five days of trading volume. That could quickly dry up in a cyclical name like US Steel, causing the costs of hedging to dramatically spike.

“This has been a tight borrow over time,” said one CB originator. “Leading up to the transaction we were consistently thinking about marketing to outright. Having said that the list of institutions that hold the existing convertible are a who’s who of our market. Part of the marketing is to try to convince them to swap into the new deal.”

Loomis Sayles (outright), AQR Capital Management (hedge fund), OakTree Capital Management (both), Calamos Advisors (outright), and JP Morgan Asset Management (outright), are the top five holders of US Steel’s 4% CBs, according to Thomson Reuters’ data.

Given that the 4s are deep out-of-the-money, those investors may very well have been inclined to roll-in cash they are likely to receive into a more balanced security.

And while US Steel has plenty of liquidity, including US$570m of cash and bank-facility availability that pushed total liquidity to US$2.4bn at end 2012, it makes sense to term out borrowings and preserve that liquidity.

It is all the better that it was able to do so at lower cash costs, and with long-term holders. Highlighting the outright orientation,

US Steel shares fell just 1% to US$19.45 over the marketing period. Versus a share price of US$19.85, 2% above reference, the new 2.75% CBs were quoted Thursday at 102.375-102.875.

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