Investment Research General Market Conditions 10 June 2013 DONG Energy Hybrid exchange offer at significant discount Today DONG Energy announced that it has abandoned its plans to change the prospectus of the call 2021 hybrid. Instead DONG will be making an exchange offer giving new NC10 hybrids in exchange for the current hybrids. The exchange offer implies a redemption price of 104, which marks a significant discount compared to the closing price last week. DONG states that if it fails to grind enough exchange acceptance, the company will use its right to call the remaining outstanding call 2021 s at 101 plus accrued interest. This is of course very negative for the call 2021. There could also be some negative spill over to the other DONG bonds, as the company could suffer from angered investors parting with their DONG positions and because DONG will now see more debt-like hybrid on its balance sheet. S&P, however, today affirmed the BBB+ rating with negative outlook. We recommend investors to accept the exchange offer, while we maintain our HOLD recommendation on all remaining DONG bonds. DONG decides to abandon efforts to change prospectus DONG Energy today announced that it has decided to abandon its efforts to change the call 2021 hybrid prospectus. In April DONG announced that it would seek to change the prospectus in order to maintain its high equity treatment of its hybrid from S&P. This follows the agency s changed requirements for 100% equity treatment. Among other things, this meant that DONG would have to change the final maturity on the bonds from 3021 to perpetuity. DONG would need to persuade Danish tax authorities that a perpetual hybrid should still be classified as a bond and subsequently be allegeable for coupon tax deductions. Today DONG announced that the process of changing the law around the tax treatment would likely be a very lengthy and uncertain process, which would probably lead to DONG s hybrid having its 100% equity treatment removed. DONG also states that it has gotten the impression from S&P that the agency will be very strict in its acceptance of hybrids with 100% equity treatment going forward. DONG interprets that, even if it was successful in changing the prospectus to satisfy the formal requirements, the Group would still be at risk of losing the 100% equity treatment if management gave indications that DONG could consider a redemption before first call. Subsequently DONG will not accept to hold a hybrid on its balance sheet with such inherent uncertainty around the future equity treatment from S&P. For more information around the methodology change from S&P see DONG Energy: New non-financial hybrid methodology, 3 April. DONG gives exchange offer for existing call 2021 The failure to change the prospectus means that DONG will formally be allowed to call the outstanding call 2021 s at a cash price of 101 plus accrued interest (accrued interest is minimal given that DONG has recently paid coupon). However, DONG has decided to offer existing holders to exchange its hybrids into new NC10 hybrids to be issued by DONG. The conversion rate will give investors new bonds in the ratio 1.04 to 1. Effectively this means that the value of exchange offer corresponds to a price of roughly 104. This marks a significant discount compared to the last closing price of 110. DONG states that the new NC10s to be issued will qualify for 50% equity treatment from S&P and will mimic structures that are currently in line with prevailing market standards. HOLD Sector: Utility, Electric Utility Corporate ticker: DANGAS Equity ticker: 1001Z DC Market cap: not listed Ratings: S&P rating: BBB+ / NO Moody s rating: Baa1 / S Fitch s rating: BBB+ / NO Analysts: Jakob Magnussen, CFA jakob.magnussen@danskebank.com +45 45 12 85 03 Louis Landeman louis.landeman@danskebank.com +46 8 568 80524 Profitability DKKm 25,000 20,000 15,000 10,000 5,000 0 Source: Company data, Danske Bank Markets Financial metrics DKKm 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Source: Company data, Danske Bank Markets 25% 20% 15% 10% 5% 0% Net sales EBITDA EBITDA-margin (rhs) Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 5.0x 4.5x 4.0x 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x Net debt Equity Net debt/ltm EBITDA (clean) (rhs) Important disclosures and certifications are contained from page 4 of this report.
They will not have mandatory coupon deferral but only optional deferral. The new hybrids will go from 50% equity credit to 0% after first call date, making it very likely that DONG will call them at 2023. DONG will seek to raise at least EUR500m. The new hybrids will get Baa3, BB+ and BBB- from Moody s, S&P and Fitch. DONG will announce the minimum spread of the new hybrids on 13 June and the exchange offer expires on 18 June, when the final new issue spread will be announced. DONG to offer cash tender offer to retail investors Following the expiration of the exchange offer period, DONG will on 20 June give a cash tender offer for the call 2021 at a cash price of 104. This tender offers only applies to amounts below EUR250,000 and as such is targeted to be an offer for retail investors. Please note that DONG has recently paid coupon on the hybrid and therefore the foregone accrued interest component from the call price is minor. DONG has also announced that if it fails to redeem or exchange all the outstanding call 2021 s, DONG reserves the right to redeem the remaining outstanding call 2021 s at a cash price price of 101. Rationale behind tender price of 104 DONG told us that the exchange price of 104 is set in an effort to share the pain with investors from S&P s methodology change. Just prior to S&P s methodology change announcement on 2 April 2 the call 2021 s traded just north of 108. Given that DONG now has the right to redeem the hybrids at 101, DONG found 104 to be a fair middleway price to share the pain with investors. In a month s time, when DONG has taken out the outstanding 100% equity treated call 2021 s and partially or fully replaced them with new 50% equity treated hybrids, it will have at least EUR350m of additional adjusted debt on its balance sheet. In isolation this would mean an adjusted net debt to LTM EBITDA metric of 6.4x instead of 6.1x based on our adjusted Q1 13 numbers. However, last week s announcement of an additional DKK1.5bn in extra EBITDA from an increased stake in the huge Ormen Lange gas field means that DONG s metrics are unlikely to be worse off when combining these two events. S&P shares this view and today the agency affirmed DONG s senior rating at BBB+ with negative outlook. Recommendation Today s announcement is a disappointment. We had thought that DONG would be successful in changing the prospectus. DONG gave the impression that it would be able to do so in its communication in April. The high price of the call 2021 s (+110 in cash price) before this announcement indicates that the market shared our optimism. DONG gave the impression that it would look out for its investors and one could have hoped for an exchange offer closer to the pre-announcement market price, or an announcement that DONG would try to change the prospectus on the call 2021 to allow for 50% equity treatment. We note that it would probably be hard for DONG to be excessively generous to investors, as management would then have to explain to Danish tax-payers why it is using public money to over-compensate bond investors. We fear that scorned investors could decide to part with other DONG bonds partially due to disappointment in the company and partially because of the increased adj. net debt position on the balance sheet. We think that excess negative price movements in DONG s other bonds would mark a buying opportunity as S&P has affirmed the rating of DONG following today s loss of 100% equity credit, and since we expect DONG to continue to be successful in its deleveraging trends. Please refer to our DONG Energy Q1 13 comment, 22 April, for more on our fundamental view on DONG. Overall we maintain our HOLD recommendation on DONG, while we suspend our previous HOLD recommendation on the call 2021 s, recommending investors to accept the exchange offer. 2 10 June 2013
Fixed Income Credit Research Head of Credit Research Thomas Hovard +45 45 12 85 05 thomas.hovard Utilities & Energy TMT Financials & Strategy Pulp & Paper Industrials Jakob Magnussen +45 45 12 85 03 jakob.magnussen Louis Landeman +46 8 568 80524 louis.landeman Thomas Hovard +45 45 12 85 05 thomas.hovard Asbjørn Purup Andersen +45 45 14 88 86 asbjorn.andersen Asbjørn Purup Andersen +45 45 14 88 86 asbjorn.andersen Henrik Arnt +45 45 12 85 04 henrik.arnt Mads Rosendal +45 45 14 88 79 mads.rosendal Brian Børsting +45 45 12 85 19 brian.borsting Mads Rosendal +45 45 14 88 79 mads.rosendal Gabriel Bergin +46 8 568 80602 gabriel.bergin Kasper From Larsen +45 45 12 80 47 kasper.from.larsen Aase Haagensen +47 22 86 13 22 ha email addresses end @danskebank.com 3 10 June 2013
Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The authors of the research report are Jakob Magnussen, Senior Analyst, and Louis Landeman, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Services Authority (UK). Details on the extent of the regulation by the Financial Services Authority are available from Danske Bank upon request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Danske Bank, its affiliates, subsidiaries and staff may perform services for or solicit business from DONG Energy and may hold long or short positions in, or otherwise be interested in, the financial instruments mentioned in this research report. The Equity and Corporate Bonds analysts of Danske Bank and undertakings with which the Equity and Corporate Bonds analysts have close links are, however, not permitted to invest in financial instruments that are covered by the relevant Equity or Corporate Bonds analyst or the research sector to which the analyst is linked. Danske Bank, its affiliates and subsidiaries are engaged in commercial banking, securities underwriting, dealing, trading, brokerage, investment management, investment banking, custody and other financial services activities, may be a lender to DONG Energy and have whatever rights are available to a creditor under applicable law and the applicable loan and credit agreements. At any time, Danske Bank, its affiliates and subsidiaries may have credit or other information regarding DONG Energy that is not available to or may not be used by the personnel responsible for the preparation of this report, which might affect the analysis and opinions expressed in this research report. Danske Bank is a market maker and may hold positions in the financial instruments mentioned in this research report. Within the previous 12 months Danske Bank has been Lead Manager of a public offer of credit bonds for DONG Energy. As an investment bank, Danske Bank, its affiliates and subsidiaries provide a variety of financial services, including investment banking services. It is possible that Danske Bank and/or its affiliates and/or its subsidiaries might seek to become engaged to provide such services to DONG Energy in the next three months. Danske Bank has made no agreement with DONG Energy to write this research report. No parts of this research report have been disclosed to DONG Energy. No recommendations or opinions have been disclosed to DONG Energy and no amendments have accordingly been made to the same before dissemination of the research report. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors upon request. 4 10 June 2013
Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates Credit Update: This research report will be updated on a quarterly basis following the quarterly result statements from DONG Energy. Scandi Handbook: This research report will be updated biannually, usually in October and April. See the front page of this research report for the date of first publication. Recommendation structure Investment recommendations are based on the expected development in the credit profile as well as relative value compared with the sector and peers. As at 31 March 2013, Danske Bank Markets had investment recommendations on 47 corporate bond issuers. The distribution of recommendations is represented in the Distribution of recommendations column below. The proportion of issuers corresponding to each of the recommendation categories above to which Danske Bank provided investment banking services in the previous 12 months ending 31 March 2013 is shown below. Investment Time Distribution of banking Rating Anticipated performance horizon recommendations relationships Buy Outperformance relative to peer group 3 months 26% 42% Hold Performance in line with peer group 3 months 49% 35% Sell Underperformance relative to peer group 3 months 26% 50% Changes in recommendation within past 12 months Date Old recommendation New recommendation 11 Jan 2013 Buy Hold 5 10 June 2013
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