Taming acquisition risk
An innovative approach to managing currency and interest rate exposure on a €6bn cross-border acquisition that might easily have failed wins Coca-Cola EuroPacific Partners (CCEP) the Risk management and resilience category in this year’s Treasury Excellence awards.
Closed in May, the deal created one of the world’s top consumer products firms. It saw Coca-Cola European Partners (EP) – already the leading bottler of the iconic US soft drink – buy out its Australasian peer Coca-Cola Amatil. But getting the deal accepted by shareholders required the bidder to sweeten its initial October 2020 cash bid for the Australian Stock Exchange (ASX)-listed target quite substantially.
As the acquisition played out in deal rooms and headlines, another lower-profile story was taking shape behind the scenes. Keen to limit its downside if the deal failed to complete during a period of increasing volatility, the Euro-based buyer put in place a raft of deal-contingent hedges.
Most obviously, this covered the Euro-Australian dollar exchange rate risk to which the bid exposed it. In addition, it covered interest rate risk on the borrowing EP would need to term out the deal’s financing.
On such a large deal, even small shifts in the exchange and/or swap rate could have upped EP’s longer-term costs significantly.
The acquisition highlights the value of contingent hedging. With the parent Coca-Cola Company having committed around a third of its 30.8% stake in Amatil to EP (on less advantageous terms than those offered to other shareholders), it could seem in hindsight as if it was always a done deal – especially as Coke also owned around 19% of EP.
But the opposite is true. Local Australian institutions and other independent holders rejected October 2020’s initial bid forcibly. After a long impasse to February 2021, EP threw in a further A$0.75 per share (around A$650 million in total) to reflect Amatil’s “improved trading and net debt position”. Winning their acceptance in this way brought the full price tag to just under A$10bn – including a higher price of A$10.75 per share for the remainder of Coke’s stake than EP was to pay for the first 10.8% (A$9.57).
Factoring in the potential for further rejection, the handful of banks that make up the contingent hedging market put the likelihood of the deal completing as low as 5% in some periods of, especially intense market speculation – and rarely higher than 35% before the higher bid. Banks will not usually price deal-contingent hedges when they estimate the probability of the deal closing at below 90%.
“It was quite a volatile process in terms of credit limit availability/amount and pricing,” recalls CCEP treasurer Cigdem Gures Erden.
These considerations were also impacted by the higher final bid price. All of the hedges had to be recalibrated to cover the increased exposure fully, while banks bidding for the hedging mandate needed to lift their risk limits even higher.
“We had to wait for the banks to reassess their risk when we had a good opportunity in the market to execute the trades,” Gures Erden recalls.
Deutsche Bank eventually supplied the bulk of the FX and rate hedges.
Rothschilds was lead adviser on the acquisition. Credit Suisse and Macquarie also advised EP, while CS arranged a €4.4 billion one year bridge loan to back the transaction too.
Unusually, EP modelled a variety of hypothetical scenarios in detail using different FX risk management strategies. These included vanilla forwards, options and other derivatives. Although options were its initial first choice, it eventually picked contingent forwards.
“The deal-contingent hedge premium is a one-off cost that you have to incur when you need the option to walk away if the acquisition does not go through,” notes Gures Erden.
Although the company looked at hedging the EUR/AUD cross-rate originally, this was not where it managed its currency exposure in the end. Instead, it traded its contingent forwards on the far more liquid EUR/USD rate while also laying off some AUD/USD risk directly with one of the sellers of Amatil shares. The latter strategy “helped us reduce the deal-contingent premium”, according to Gures Erden.
In the event, both the FX forwards and the forward-starting swap put in place to manage interest rate exposure on the all-cash deal’s funding closed far in the money. This also contributed to lowering CCEP’s premium.
“The main challenge was the fact that we did not know when we would close the transaction and when we would do the bond issuance, or which maturities and amounts,” recalls Gures Erden. In particular, EP needed the capacity to terminate its hedges early without hurting its earnings or its auditors classifying them as ineffective.
This “required a lot of detailed discussions with our banks on how to best structure that uncertainty into the process and the documentation and the pricing”.
Besides certainty over its costs and avoiding tax or accounting issues, a further benefit of the strategy was to simplify EP’s discussions with ratings agencies seeking to assess the deal’s impact on its credit standing. Moody’s eventually downgraded the company one notch to Baa1 from A3.
With its swap in place EP eventually took out its bridge loan, committed in October 2020, through a raft of bond issues this April. Lead managed by EP’s loan arranger CS (€3.25 billion across 4, 8, 12 and 20-year maturities) and contingent hedge counterparty DB (US$2 billion in 2, 3, and 5-year tenors), each offered a one-point redemption premium if the Amatil acquisition were not consummated before the end of 2021.
Despite Moody’s downgrade, the deals attracted notable investor support. The euro tranches drew total demand of over €8bn and the dollars more than $5 billion, according to Refinitiv data.
It also pre-funded part of the deal with a €750 million 8-year bond in November 2020 before Moody’s downgrade. This saw buyers put in €2.1 billion of orders at the launch spread.
Factoring in the price of the hedge, this strength of demand contributed to EP’s competitive all-in cost of 40bp over mid-swaps.
Coca-Cola European Partners (CCEP) will be presenting at the 30th anniversary International Treasury Management Virtual Week from Sept 27 – Oct 1. Registration is free for corporate treasurers. Click here to find out more and reserve your place.