Flashnote Global Research European Credit Research Wind Acquisitions Refinancing options and trade ideas It s nearly crunch time for Wind as the date when its PIKtoggle notes become cash bonds is approaching Given weak cash flow, Vimpelcom s support could be needed, in our opinion, as part of a market-based solution Most upside is currently in the PIK-notes and/or through selling CDS Refinancing and trade ideas We expect Wind to be able to refinance its debt although, given weak financial performance, Vimpelcom, its owner, may need to assist. In our opinion, it would be unwise for Vimpelcom to pierce the ring-fence currently separating its creditors from Wind s, as this would expose Vimpelcom s creditors to additional risk and would be unlikely to lead to a meaningful cash interest saving for the group. Therefore, Vimpelcom s assistance may be only partial and conditional on additional refinancing of Wind debt in the market. Lior Jassur Head of Credit Research EMEA HSBC Bank plc +44 20 7991 5632 Lior.jassur@hsbcib.com Laura Maedler Analyst HSBC Bank plc +44 20 7991 1402 Laura.maedler@hsbcib.com View HSBC Global Research at: http://www.research.hsbc.com Issuer of report: HSBC Bank plc Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it The company s high coupon bonds are callable on any day subject to a 30 day notice, thus rendering yield and spread considerations meaningless. The company s EUR and USD 11.75% 2017 notes trade at, or near, their call price offering no upside potential, but the PIK-toggle notes offer a 3 point upside potential from current prices, thus we assign a BUY trading call to the company s 12.25% PIK-toggle notes. If the company refinances its expensive debt, we expect Wind s 5 year CDS, currently around 540bp, to tighten towards the mid-to-low 400bp on reduced refinancing risk; thus, for investors that prefer to stay at the senior unsecured level, we recommend selling 5 year CDS at 540bp or wider. Recommendation We reiterate an Underweight fundamental recommendation on Wind, as the challenging conditions in the Italian economy are likely to place significant pressures on the company (and other companies), as has been the case in other European countries recently. As a result of these pressures, top-line growth is likely to be negligible and de-leveraging is likely to remain elusive. The company, a major alternative telecom operator in Italy, was acquired by Vimpelcom in 2011 and, although we analyse Wind on a standalone basis, we view Vimpelcom s ownership as a credit positive. In recent years, Wind s net cash flow before financing has been weak and it is unlikely, in our view, to improve meaningfully in the near future, placing pressure on the sustainability of the company s capital structure. Upside risks include: (i) improved performance as the company gains market share at the expense of others; (ii) stabilisation of the economic situation in Italy; (iii) explicit financial support for the company from its parent; and (iv) lower competition after consolidation in the market. We acknowledge the assistance of Benjamin Walker (HSBC Bank plc) in the production of this report.
Pressure to refinance Wind Acquisition s capital structure was put together prior to its acquisition by Vimpelcom in 2011 (Figure 1); its PIK-toggle bonds and 11.75% senior unsecured notes were issued in July 2009 and are now within their call period. The amount of debt, and the high coupon the bonds carry, mean that a significant amount of Wind s cash flow is used up in debt service. In recent quarters, the company s cash flow before financing has been very thin, leaving virtually no free cash to finance the PIK s coupons, dividends to the parent or debt reduction, as can be seen in Table 1: Table 1: Wind Acquisition's cash flow over time (EURm) Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Op cash flow excl. interest expense 445 483 436 628 480 417 510 688 363 376 Cash interest expense (212) (169) (188) (152) (230) (151) (222) (180) (205) (164) Cash capex, net (146) (136) (223) (1,534) (192) (240) (219) (340) (162) (182) Free cash flow before financing 87 177 25 (1,058) 59 25 69 168 (3) 29 Source: Company data, HSBC calculations Once the group s PIK-toggle bonds, which have a 12.25% coupon, become cash pay in January 2014, we estimate they will add a further EUR153m to Wind s annual cash interest expense, raising it from EUR771m LTM to Q2 2013 to EUR924m in FY2014. Based on the company s recent cash flow generation as shown in Table 1, even if it were possible to upstream cash to the PIK-issuer, it seems there is not enough cash being generated to upstream. The PIK-toggle bonds are in a very weak position and Wind, as well as its parent Vimpelcom, needs to address its capital structure as a matter of some urgency. Refinancing options Assuming that operating cash flow excluding interest expense cannot be improved rapidly, the focus of any refinancing at Wind needs to be, in our opinion, on cutting cash interest expense and extending debt maturity. An obstacle to taking such steps is the complex structure of the company (see Figure 1) and the restrictions on up-streaming cash between the different holding companies in the structure. On its Q2 2013 earnings conference call, Vimpelcom s outgoing CFO noted that Wind s peak debt maturity is in 2017 and stated that the plan is to refinance this debt before maturity and that an inhouse bank (i.e. financing subsidiary) based in Luxembourg is now in place through which Vimpelcom structured around USD500-700m of inter-company loans although the plans for the future are still in the development stage. Whilst we view refinancing of Wind s debt through Vimpelcom as a credit positive event for Wind creditors, it is not clear to us that this will be a necessarily positive event for Vimpelcom itself. In this section we highlight possible options and rank them according to whether they favour Wind creditors, Vimpelcom creditors, or both. Full refinancing through Vimpelcom Positive for Wind creditors, Negative for Vimpelcom creditors Wind s total debt is around USD14.1bn, out of Vimpelcom s total debt of USD27.4bn in other words Wind accounts for 51% of Vimpelcom s total debt. The current financing structure of Vimpelcom, as shown in Figure 1, means that Vimpelcom s creditors are not exposed to Wind s credit risk. According to our interpretation of Vimpelcom s and Wind s capital structure, if Wind were to encounter liquidity difficulties, its creditors have no claim on Vimpelcom s assets outside the ring-fenced group therefore 2
the current structure affords some protection to Vimpelcom s creditors from Wind s credit risk. This is reflected in Vimpelcom s senior unsecured bond rating of Ba3 / BB, compared with Wind s senior unsecured bond rating of B3, Negative Outlook / B. By bringing Wind s credit risk into the Vimpelcom capital structure without ring-fencing, Vimplecom risks a higher cost of debt in the future: Wind s current cost of debt, when including the PIK-toggle bonds is around 8.9%. We estimate Vimplecom s cost of debt, excluding Wind, to be around 7.9% (USD13.3bn gross debt and annualised cash interest expense of USD1.05bn). As Wind accounts for approximately half of Vimplecom s consolidated debt, combining all debt together would result in an estimated cost of 8.4% a small saving for Wind of around USD89m cash interest expense per year, and a similar increase in cash interest expense for Vimpelcom excluding Wind. Refinancing Wind on a stand-alone basis Neutral for Wind creditors, Positive for Vimpelcom creditors A piecemeal refinancing of Wind s debt, without recourse to Vimpelcom, would provide a solution to Wind s problems without exposing Vimpelcom s creditors to additional risks. Furthermore, if free cash flow can be improved through refinancing Wind s debt at lower costs on a stand-alone basis then Vimpelcom, as owner, would benefit from a more stable subsidiary with better prospects of deleveraging over time. At the time of writing, Wind s EUR 7.375% 2018 senior secured bonds are trading at a yield to maturity of around 6.7%. Adding 300bp for senior unsecured bonds and 450bp for subordinated bonds (to refinance existing PIK-toggle notes) would reduce cash interest expense by around EUR70m and achieve debt maturity extension. Reducing Wind s cash interest expense by EUR70m, assuming operating cash flow remains stable, would leave around EUR1.1bn of cash flow to cover capex and reduce debt. Partial refinancing through Vimpelcom Neutral/Negative for Wind creditors, Positive for Vimpelcom creditors As owner of Wind, Vimpelcom needs to ensure that its position in the company is protected if Wind s capital structure becomes unsustainable in the future. Vimpelcom could use its Luxembourg financing subsidiary to extend a senior secured loan to Wind. This could reduce Wind s cash interest expense and improve its free cash flow if done in conjunction with refinancing in the market (i.e. without Vimpelcom s money) of Wind s 11.75% and 12.25% bonds. In such a scenario, if Wind encountered financial difficulties in the future, Vimpelcom would rank ahead of senior unsecured creditors through its loan to Wind; if Wind were able to embark on a virtuous cycle of debt refinancing and de-leveraging, then Vimpelcom, as shareholder, would be able to extract value, having protected its position against a downside scenario. Conclusion Given the potential risks to Vimpelcom, and the relatively small benefit in terms of interest expense for Wind, we view the option of financing Wind entirely through Vimpelcom s financing subsidiary as unattractive. A stand-alone refinancing appears to be the one more favourable for Vimpelcom although it may be difficult to achieve given Wind s recent weak performance. Therefore, we view a partial refinancing through Vimpelcom as the most likely scenario for Wind. 3
Figure 1: Wind within Vimpelcom's capital structure VimpelCom Ltd. Vimpelcom Amsterdam Finance B.V. VimpelCom Amsterdam B.V USD 2.7bn intercompany loan VimpelCom Holdings BV OJSC VimpelCom PJSC Kyivstar Total OJSC Group USD 8.2bn VIP NL USD 4.2bn WIND Telecom S.p.A Weather Capital S.a.r.l Wind Acquisition Holdings Finance S.p.A. USD 2.7bn shareholder loan (PIK) Weather Capital Special Purpose I S.A. Orascom Telecom Holding S.A.E WIND Telecomunicazioni S.p.A. Wind Acquisition Holdings Finance SA EUR392m 12.25% PIK/Toggle Notes 2017 USD754m 12.25% PIK/Toggle Notes 2017 EUR400m L+400bp Snr Secured RCF 2016 EUR37m L+400bp Snr Secured TL A1 2016 EUR303m L+400bp Snr Secured TL A2 2016 EUR1,334m L+425bp Snr Secured TL B1 2017 EUR681m L+450bp Snr Secured TL B2 2017 USD 2.5bn uncommitted credit facility (PIK) USD 0.7bn drawn OTH subsidiaries USD 0.9bn Wind Acquisition Finance SA Ring fenced EUR1,750m 7.375% Snr Secured Notes 2018 EUR200m 7.375% Snr Secured Notes 2018 USD1,300m 7.25% Snr Secured Notes 2018 USD400m 7.25% Snr Secured Notes 2018 EUR150m E+525bp Snr Secured Notes 2019 USD550m 6.50% Snr Secured Notes 2020 EUR1,250m 11.75% Snr Unsecured Notes 2017 USD2,000m 11.75% Snr Unsecured Notes 2017 Source: Company data, HSBC 4
Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Lior Jassur and Laura Maedler Credit: Basis for financial analysis This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations. HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its credit research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a six-month time horizon; and 2) from time to time to identify trade ideas on a time horizon of up to three months, relating to specific instruments, which are predominantly derived from relative value considerations or driven by events and which may differ from our long-term credit opinion on an issuer. HSBC has assigned a fundamental recommendation structure only for its longterm investment opportunities, as described below. HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice. HSBC Global Research is not and does not hold itself out to be a Credit Rating Agency as defined under the Hong Kong Securities and Futures Ordinance. Definitions for fundamental credit recommendations Overweight: The credits of the issuer are expected to outperform those of other issuers in the sector over the next six months Neutral: The credits of the issuer are expected to perform in line with those of other issuers in the sector over the next six months Underweight: The credits of the issuer are expected to underperform those of other issuers in the sector over the next six months Prior to 1 July 2007, HSBC applied a recommendation structure in Europe that ranked euro- and sterling-denominated bonds and CDS relative to the relevant iboxx/itraxx indices over a 3-month horizon. 5
Rating changes for long-term investment opportunities Recommendation History of WIND ACQUISITIONS FINANCE SA From To Date Neutral Underweight 2012-10-10 Overweight Neutral 2012-01-18 Not Rated Overweight 2011-01-19 Source: HSBC Distribution of fundamental credit opinions As of 21 August 2013, the distribution of all credit opinions published is as follows: All Covered Companies Companies where HSBC has provided Investment Banking in the past 12 months Count Percentage Count Percentage Overweight 164 25 104 63 Neutral 356 55 161 45 Underweight 130 20 50 38 Source: HSBC HSBC & Analyst disclosures Disclosure checklist Company Ticker Recent price Price Date Disclosure WIND ACQUISITIONS FINANCE SA - - - 11 Source: HSBC 1 HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 July 2013 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 June 2013, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 June 2013, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 30 June 2013, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-us Market Maker in securities issued by this company and/or in securities in respect of this company HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. 6
* HSBC Legal Entities are listed in the Disclaimer below. Additional disclosures 1 This report is dated as at. 2 All market data included in this report are dated as at close 21 August 2013, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 7
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