As part of the quest for reliable alternative sources of funding, private placements are high on the agenda for treasurers. We explore the ins and outs of this robust option.
With the possibility of securing long-term, fixed-rate funding, private placements of debt securities provide treasurers with an alternative to the usual bank loans and public bond issues.
Often attracted by the private, and thus more personal nature of these placements, corporates have the ability to access the capital markets without the need for obtaining a credit rating. However, it’s not all a one-way street. A private placement’s success relies heavily on the treasurer’s and the investor agent’s ability to structure and negotiate the terms of transaction.
What is a private placement?
A private placement enables a company to raise funding by offering shares, stocks, bonds or securities to a small group of sophisticated investors.
Investors of private placements could include larger banks, mutual funds, insurance companies and pension funds. Since these placements are only offered to a few individual investors, buyers can request a custom-built financial plan from the issuing company. Using this approach, potential investors can assess the deal and see if it precisely meets their investment criteria.
The market in general
Historically, the long-established US private placement market is the model to follow, US investors having taken advantage of an exemption to the SEC registration and business prospectus requirements in the 1933 Securities and Exchange Act.
The market has ‘internationalised’ over the years, with nearly half of all placements now coming from non-US issuers. That said, leading investors in the private placement market remain solidly institutional and US-based.
In recent years, institutional investors have become interested in less traditional assets due to lacklustre normal market yields. More adventurous investors are buying stock through private placements, seeing it as a safer way to yield than heading into the junk markets.
On the issuer side, in a loans market partly constrained by Basel III capital requirements exerted on banks, mid-range businesses especially with their less attractive smaller wallets and limited ancillary business, could see a way forward with private placements.
Perhaps as a result of this, the smaller private placement markets in Germany (the ‘Schuldschein’), the UK and France and have expanded in recent years.
Why would a corporate issue a private placement?
Direct investor relationship
The beauty of a private placement can be found behind the scenes. Because more shares are bought by fewer investors, they have the power to request a private placement memorandum (PPM). This is similar to a bespoke business plan for buyers. Buyers can see exactly how shares would help the issuer, allowing for more complex business circumstances and investment stories to be communicated effectively. Business sensitive information is always subject to an NDA, so the level of publicity often seen with a public offering is avoided, which may suit both sides.
Variety is the spice of life and private placements offer help in this department, providing treasurers with an alternative source of funds to the usual bank loans or public bond issuance.
Access to capital markets without a credit rating
A key difference between private placements and public offerings is credit ratings: placements don’t need one. Whereas most public debt issues require at least one credit rating from a recognised credit agency, private placements allow companies without a long-term credit rating (or simply those that don’t want a long-term rating) to access capital markets. The lack of a credit rating doesn’t mean the placements have a low credit quality though; placements are usually investment grade, with issuers typically having an implied credit quality of AA to BB.
Diversification of funding sources
Variety is the spice of life and private placements offer help in this department, providing treasurers with an alternative source of funds to the usual bank loans or public bond issuance. This allows companies to easily diversify and thus make secure their funding sources, potentially freeing-up additional credit lines or enabling refinancing of existing bank loans.
More breathing room for issuers and investors
One of the good things about having such a personal relationship between issuer and investor is the increased freedom for both parties when making business decisions. Placements generally give the issuing company more breathing room in the disclosures it makes to potential investors. The theory is that buyers will make sure they know exactly what they’re buying when investigating shares. In terms of advantages for investors, the private market gives borrowers the opportunity to delay funding for 12 months or longer, as opposed to the public market where a transaction is funded just a short time after it has been priced. It can therefore secure funding for when it really needs it, not just when it can get it.
Competitive pricing and flexibility
The fact that the process of offering debt placements to a limited number of investors is private, means relatively competitive pricing is assured. There is also greater flexibility in structuring the debt issue, with issuers and investors laying out individual finances on the table before investors look at buying.
Another bonus for companies issuing private placements is that they could potentially avoid significant underwriter fees; things like formal registration in the US, for example, and publishing a prospectus, all cost money, and it can be very helpful if such things can be avoided.
Why do investors invest?
Private placement investors are usually sophisticated, institutional investors, who will take the time to fully research and analyse the credit of the issuer. Most of the time, investors will be insurance companies, larger banks, mutual funds and pension funds.
In some cases, because the investor is buying more shares, they expect a higher rate of interest than they might earn on a publicly traded security, thus they are able to achieve slightly higher returns than can be achieved by investing in comparable publicly traded securities.
Also, because issuers may not have a credit rating, investors may not buy unless secured with specific collateral. This, accompanied with the fact that investors are often buying stock from less well-known names means they may expect a higher percentage of ownership in a business or a fixed dividend payment per share of stock.
About a decade ago, investments in Asia were moving into bubble territory. Eventually, there was little for investors to purchase on Asia’s underdeveloped capital markets. There was a period of prosperity for private placements as investors bought up all the debt they could in this market.
Whilst public placement accounts for the majority of corporate bond issuance in a number of Asian countries such as China, Malaysia, the Philippines and South Korea, its private counterpart thrives in other markets, like India. Here, private placements have remained the primary form of bond issuance, representing more than 80% of the corporate bonds issued domestically in 2012 and 2013. In 2015, private placement debt in India was at an all-time high, with 2,953 companies using this route.
Public bond issuances in the US still outweigh privately placed debt 80/20, despite the latter being on the rise generally speaking. In 2015, new issues of private placements amounted to US$49bn. This compares with more than US$1trn in the public corporate bond market during the same period. In 2015, US$578.9bn or 20.9% of insurance companies’ total bond portfolio was in private placements, up from US$531.5bn in 2014.
Before 2014, Europe was unable to recreate the thriving US market, where insurers, pension funds and other investors avoided public markets to buy billions in private placements.
A year later, in 2015, it looked as if the European private placement market was expanding but fragmented, with pockets of regional activity in areas such as Germany, France and an emerging market in the UK.
Over the last few years, momentum has been growing towards the establishment of a pan-European private placement market (Euro PP), which is envisaged will complement the established US private placement market.
Indeed, many European companies in search of private placement money still head to the US for it. About a third of the US market consists of placings for European companies.
Despite these developments, the US market looks to remain dominant, at least for the foreseeable future. The continued need by many global corporates for dollars remains a strong advantage. Perhaps the private placement market in Europe can continue to gain momentum and achieve the capital success of America it desires.
In 2017, Apple broke into the Canadian ‘maple bond’ market for the first time, raising US$2.5bn in private placements. In a filing with the US SEC, Apple said it planned to use the funds for general corporate purposes. Investors included institutional clients HSBC Bank Canada, RBC Dominion Securities, BMO Nesbitt Burns and Goldman Sachs Group.
Private placements have continued to grow over the last ten years, and not just in underdeveloped capital market countries. Boasting many positive factors for both the issuer and investor, it is easy to see why placements are, in some parts of the world, outweighing bonds offered to the public by a factor of 4:1.
As leading US companies continue to invest in these more personal corporate deals, European markets remain for now the poor relation, at least in terms of deal size and volume. With capital markets rising and falling in different parts of the world, private placements can act synchronously to meet the ebb and flow of need.
As part of the treasurer’s funding arsenal, it is likely that private placements will be in demand for some time to come. Investors, it seems, are happy to oblige.