Patience pays for Telstra and Euro investors

Telstra completed its European debt investor roadshow last week and on Monday night sold €1.0 billion of ten-year bonds at just 103 basis points over mid-swaps. It seems that European investors have always placed a high value on telco debt and this continues to hold for Telstra.

Since Telstra undertook its last 'public' bond issue in the domestic market, raising $500 million for eight years in March 2005, the telco has raised almost the equivalent of $7 billion in the Euromarket market, including this latest issue.  

Telstra tried to sell $500 million of ten-year bonds last November. That would have effectively replaced an identical issue that matures at the end of this month.
Those bonds were issued ten years earlier when Telstra was still rated 'AA+' by S&P and were issued at a spread of just 35 bps over swap. Its share price at the time was near to $8.

Last November, Telstra wanted the market to accept a credit spread of 150 bps over swap, when its 'A' rating from S&P had a negative outlook and Moody's had the 'A2' rating assigned to Telstra on review for possible downgrade.

Not surprisingly, domestic investors sought some protection from a further deterioration in the credit quality of Telstra in the form of provision for coupon step-ups upon downgrades.

And, given the ongoing uncertainty over the Commonwealth government's proposed structural reforms for the sector and Telstra, investors sought protection against any structural separation that may yet be imposed.

Telstra declined on both counts and the deal did not proceed.

It is not known whether the market was prepared to accept a margin of 150bps at the time or not. But as observed then, the pricing sought seemed very aggressive with no domestic benchmarks to support the pricing.

Even the big four banks were not achieving such levels offshore, after hedging back to Australian dollars. This newsletter noted at the time that only a few days earlier Westpac issued 10-year bonds in the US and had to pay 155 bps over US Treasuries, which should have converted back at 165 bps or more over swap, in the domestic market.

Four months later, Telstra has all but achieved the pricing that it demanded.
 
With the ten-year Australian dollar, euro, basis swap at about 55 bps, the hedged credit margin that Telstra will pay on the bonds should be just under 160 bps.

But according to reports, even the European investors demanded protection against further deterioration in Telstra's credit quality and any structural separation or other changes that may be imposed.

Moody's still has Telstra's credit rating on review for possible downgrade and Fitch recently joined its peers, placing a negative outlook on its 'A' rating assigned to Telstra. Fitch cited concerns over the impact structural change and increased competition may have on Telstra's operating performance going forward, for the outlook revision.