Markets

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

(Corrected )

Bayer AG has found a new best friend in the convertible bond market. With the $66 billion takeover of crops giant Monsanto Co. to finance, it needs all the allies it can find.

Fresh from November's sale of 4 billion euros ($4.5 billion) of notes that convert into shares, the German drugmaker scored a further 2.1 billion euros from offloading stock and convertible securities in chemical maker Covestro AG, in which it holds a 45 percent stake.

On the Recovery Path
Bayer's stock, hit by the plan to buy Monsanto, has rallied in recent months
Source: Bloomberg

The new convertibles only yield 0.05 percent per annum. But the real rate is negative: They were sold at 105.25 percent of their principal amount; at maturity, investors could get back less than what they put in.

Investors were willing to pay up because the latest securities can be swapped for Covestro shares if that company's stock touches 80.93 euros, about 30 percent above where it is now. If Covestro's stock goes higher still, bondholders stand to make a neat profit.

For investors, this long-dated option on Covestro has real scarcity value. There's no liquid market to speak of in Covestro three-year stock options. Sure, you could ask an investment bank to enter into a derivatives contract on a bespoke basis, but it wouldn't be easy to trade and the economics would favor the bank.

Against that backdrop, Bayer was able to set the terms to its advantage in this case. Investors lapped up the issue. The new convertibles immediately traded higher on Wednesday, having being sold at the midpoint of their marketing range, according to a person familiar with the matter.

Bayer has effectively sold some of its Covestro holding at tomorrow's prices. True, if Covestro stock doesn't rise to the conversion price, Bayer has to repay the bond. Still, there's no downside for the company.

Easy Sell
Bayer can take profits on its Covestro stake to fund its Monsanto takeover
Source: Bloomberg

For bondholders, the outcome is less certain. Some hedge funds will already have sold out on the convertible's early jump. Other other money managers may have been forced to buy in if the notes are included in benchmark indices they track. They'll be crossing their fingers that Covestro's stock shifts higher -- it's down 3 percent this year -- because otherwise they've financed Bayer on some pretty generous terms.

Don't expect to see deals like this when interest rates cease to be negative -- or if convertible issuance ticks up and investors have more choice. For now, such transactions have scarcity appeal. No wonder Bayer is making hay while the sun shines.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects sixth paragraph to show bonds were sold at the mid-point of the price range)

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net