Photo of Lillian Sim, J.P. Morgan, Serene Tan, Rebecca Kang, Colin Teo, ST Engineering and Victor Leow, Bank of America.

USCP, bond market and T-locks help STE navigate its largest acquisition to date

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The challenge

Singapore Technologies Engineering Ltd (STE) announced the US$2.68bn acquisition of US firm TransCore in October 2021 to bolster its smart city growth.

Various factors created a historically challenging environment for a deal of this size and importance:

• At the end of 2021, the interest rate environment was highly volatile and uncertain, driven by rising inflation in the US and initial signs of a FED pivot. While there was no consensus, there was an increasing risk of material rate rises for the first time in a decade.
• The acquisition of a US company required several conditions to be met including approval from the Committee on Foreign Investment in the US. There was no certain timeline of the deal approval.
• Once approved, the purchase agreement required closure within three business days, creating an incredibly tight window for bond issuance and high exposure to market conditions.

With no certainty of completion, raising funds early and placing them in the money markets would have carried a high cost and been value destructive. The STE treasury team prioritised risk management and took an approach of focusing on funding flexibility and optionality with a reasonable level of rate certainty.

The solution

To achieve a basic level of funding flexibility, the team expanded their US Commercial Paper (USCP) Programme from US$1.5bn to US$3bn. STE was the first Singapore-based corporate issuer to establish this programme in 2019. Correspondingly, an incremental US$2.3bn backstop revolving credit facility (RCF) was established to support this USCP programme upsize.

With a target hedge ratio of 50% of the prospective issuance size, the team used Treasury Locks (T-locks) – which hedges the price of the bond to the underlying US treasury security – to achieve a level of rate certainty by locking in interest rates without raising funding. A T-lock is an appealing risk management instrument since it is an easily identifiable benchmark with high trading liquidity.

A US$1bn T-lock programme was executed through ten tranches dealt between October-December 2021 (dollar-cost averaging). The execution strategy of dealing in tranches, and placing orders proved effective. In most cases, rates were locked-in at intra-day lows.

By spreading out the T-locks execution in multiple tranches, STE achieved a hedging rate that is approximately 9.2% lower than if the company had completed all tranches on the first day at 1.80%.

The acquisition closed on March 17th 2022 and was funded by short-term USCP. On April 26th 2022, amidst softer bond market conditions due to the breakout of conflict in Europe and uncertainty over the interest rate environment, STE managed to raise US$1bn of five and ten-year bonds while continuing to fund the balance via its USCP programme. Despite the volatility, STE successfully tightened spreads by 30bps from initial price guidance and the utilisation of T-lock settlement gains brought the all-in rate down by approximately 1.12% vs prevailing treasury yields.

This combination of USCP, bond market financing and T-locks, helped STE navigate through the volatility and uncertainty while achieving high levels of flexibility and improving overall deal costs.

Best practice and innovation

STE has fundamentally demonstrated best practice in its funding risk management approach. While the solution hinged on the use of T-locks, the company’s approach was holistic and is reflected in its risk policy and execution.

Given interest rate movements, it could be argued that higher levels of hedging would have created more value. Yet, by staying within policy and avoiding the temptation to take a position, the team ensured the flexibility during their issuance window to deal with an unforeseen market event, while still managing to achieve a favourable outcome.

Key benefits

• Cost savings.
• Return on investment (ROI).
• Risk mitigated.