September 7, 2016 / 3:46 PM / 3 years ago

Schaeffler PIK to push boundaries on size and price

* Biggest post-crisis PIK toggle lined up

* Opco upgrade improves chances of low coupon record

By Robert Smith

LONDON, Sept 7 (IFR) - Schaeffler is looking to price the largest post-crisis PIK toggle bond, in a 2.5bn-equivalent deal that is expected to have the lowest coupons yet seen for the risky instrument.

The German bearing maker plans to raise a senior secured payment-in-kind toggle note split into euros and US dollars, with maturities of 5NC2, 7NC3 and 10NC5.

These bonds will refinance the company’s existing PIK toggle notes, which have coupons ranging from 5.75% to 6.875%. Investors expect dramatically lower coupons on the new notes, with one portfolio manager expecting a low-to-mid 3% yield on the five-year euro tranche.

PIK notes are deeply subordinated debt instruments that allow companies to pay coupons with additional bonds rather than cash. PIK toggles are a twist on the format where the security can toggle between either paying coupons in cash or additional bonds.

Schaeffler has a track record for setting major PIK toggle milestones. In 2013, it raised over 1.5bn-equivalent across euros and dollars. It then returned in October 2014 with a 1.2bn-equivalent PIK.

These bonds refinanced holding company debt primarily incurred when Schaeffler was left holding 90% of German tyre maker Continental’s shares after a tender offer launched in 2008 coincided with the collapse of Lehman Brothers and a sharp drop in global equities.

Schaeffler has so far serviced all of the coupons on its existing PIK toggle notes with cash and not additional debt.

The company has overhauled its corporate structure significantly since it last came to the PIK market, having publicly listed the Schaeffler AG operating company last year.

The new PIK notes sit at a holding company level above this, which will be renamed IHO Verwaltungs that owns a 36% stake in Continental. A remaining 10% stake in the tyre maker will sit at IHO Beteiligungs, another holding company above the PIK notes.

One investor argued that given the operating company upgrade Schaeffler may be able to push pricing beyond low-to-mid 3%.

“Each PIK from Schaeffler has reset the bar lower. It’s the world we live in - when the opco bonds are trading in the ones [percent yield] that’s where we are,” he said.

Moody’s upgraded Schaeffler AG to an investment grade Baa3 rating on Wednesday. It expects to rate the new PIK notes at Ba1, several notches higher than S&P’s B+ rating.

The investor added that the new deal also has some covenant changes from the old PIKs, “some for the better and some for the worse”.

“Basically they can incur more debt, although it depends on where the Conti share price is as it all links back to that in terms of security,” he said.

As the PIK notes are senior secured, they have direct security on the holding company’s 36% stake in Continental. The PIK has new covenants allowing the issuer to incur additional debt if its loan-to-value ratio is less than 1:2.5, along with a “combined coverage ratio” of at least 2:1.

Schaeffler is targeting pricing of the new deal on Thursday.

Global coordinators are Deutsche Bank and Citigroup, who are B&D on the euro tranche and dollar tranche, respectively. Bookrunners are Bank of America Merrill Lynch and HSBC. (Reporting by Robert Smith; editing by Alex Chambers)

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