Supply-starved European junk market offers opening to gunmaker

When the German government blocked arms sales from Heckler & Koch to the Middle East in 2014, many investors thought that the gunmaker would never be able to raise debt again.

But the German company has hosted investor meetings in recent weeks to gauge appetite for a new bond deal. Feedback indicates that most investors want a yield north of 8 per cent to buy a new seven-year bond, according to several sources close to the deal.

That there is appetite for an offering from the likes of Heckler & Koch, which was unsuccessfully sued in 2009 by lenders for allegedly allowing majority owner Andreas Heeschen to use the proceeds of the loans to buy a yacht and a private plane, reflects the dearth of high-yield paper in the European junk bond market. Flush with inflows, managers are looking to put money to work and the gunmaker may have picked the perfect time to return to market.

Kristian Orssten, head of Emea debt capital markets at JPMorgan says: “It’s no surprise that companies are taking advantage of the historically low yield environment, but investors are crying out for new money deals and there are just not many of them coming through.”

While the gunmaker is rated Triple C — the lowest bracket before default — one of the sources says it is targeting a stronger Single B rating for the new deal. And with the Single B index yielding little over 3 per cent, it is increasingly difficult to find an 8 per cent yield in the so-called high-yield market.

Heckler & Koch, which is seeking to to refinance its €220m 9.5 per cent note maturing next year, did not respond to requests for comment.

It has been the slowest start for Single B rated supply in years, with the exception of 2016 when a global sell-off shut the market. The first quarter of 2017 saw just €6.6bn of Single B rated high-yield bonds issued in Europe, according to S&P Global’s unit LCD, compared with €8.7bn in the first quarter of 2015, €7bn in 2014 and €9.3bn in 2013.

The supply shortage in high yield is particularly acute as many riskier borrowers have opted to refinance bonds in the even more buoyant leveraged loan market. As a result, the Single B bonds that have emerged have mostly come at razor-thin yields, with Netflix’s debut euro deal offering just 3.625 per cent last month

More and more leveraged finance deals are also simply recycling old debt. “Volumes have been decent but around three quarters of the deal flow this year has been straightforward refinancing,” says Mr Orssten.

Plunging yields have also spurred banks to up the aggression.

“There’s a strong suspicion that some deals have been bought recently and banks have had to work them aggressively to get to the price they needed,” says Jeff Mueller, a high-yield portfolio manager at Eaton Vance.

So called “bought deals” are when banks offer hard underwriting to win a bond mandate. This guarantees that the issuer will not have to pay more than an agreed rate of annual interest, but leaves underwriters on the hook if they cannot sell the deal at that price.

Several bankers say that Morgan Stanley backstopped a €1bn bond for Grifols last month, which carried one of the lowest-ever coupons for a Single B rated deal — just 3.2 per cent. A spokesman for the Spanish pharma company would not comment on whether it was underwritten.

While Heckler & Koch’s troubled history has put some investors off, one fund manager said he would consider buying the bonds as the German firm is “a very different company today”.

Earnings fell off a cliff after the export block and bond prices soon followed, with the value of its debt collapsing to just 64 cents on the euro in April 2015. Now, Heckler & Koch focuses on selling arms to what it dubs “Green countries” — which are members of Nato, “Nato-equivalent” or the EU, with reputable rankings on transparency and democracy indices — and earnings have recovered substantially.

Mr Heeschen actually injected €60m of cash into the group in November 2015. And management said in the recent meetings that they might raise more equity to back the new deal.

“If they put equity in, it might be all right,” says the fund manager. “But I suspect they’ll only do that if they absolutely need to.”

And for investors bored with the lack of thrills in the market, Heckler & Koch hosted a site visit at its plant in Germany last week. Several investors say that previous site visits have offered the opportunity to fire guns.

“Boys and toys,” says the fund manager. “It’s how they’ve got deals done in the past.”