First-mover advantage
PPL, a US regulated utility, added a US$1bn five-year convertible bond to its funding complex in February, providing a lower-cost alternative to straight debt and setting a benchmark for other utilities.
PPL’s first-mover advantage enabled it to price the CB at a 2.875% coupon and 22.5% conversion premium, through the aggressive end of the 3%–3.5% talk on the coupon and the top end of 17.5%–22.5% premium guidance.
"We started thinking about a convertible bond as a funding tool to mitigate interest expense in September 2022," said Tadd Henninger, PPL’s treasurer. "At the time, we were concerned that interest rates were going to be higher over the next five years."
Higher interest rates not only would make it more expensive to issue straight debt but also put pressure on PPL’s share price.
PPL timed the CB perfectly, launching the deal on Tuesday, February 21 and pricing that evening, having delivered its full-year results the previous Friday.
After hovering at near-zero percent rates for years, five-year Treasuries surged from below 4% in February to near 5% by October.
Morgan Stanley, JP Morgan, Credit Suisse and RBC Capital Markets acted as joint bookrunners on the CB, which was rated Baa1/BBB+ by Moody’s and S&P.
By Henninger’s estimate, the 2.875% annual interest rate was 250bp lower than equivalent straight debt – in late February, PPL sold US$600m 10-year straight debt at a 5% coupon (5.128% yield including the discount).
The debt-for-debt equivalent comparison only makes sense if PPL shares do not rise to levels where conversion of the CB would be overly dilutive to EPS.
In reporting 2022 results, PPL reaffirmed plans to grow earnings per share by 6%–8% annually through 2025 and estimated it would spend US$12bn on capital expenditures through 2026. PPL CEO Vincent Sorgi had said no equity issuances were needed to support the growth "throughout the planning horizon".
The decision to pivot to the CB market, raising the possibility of issuing equity, was not embraced by all shareholders, at least initially.
"When we hit the wire with the convertible debt offering, my phone started ringing off the hook," Henninger said. "'What are you doing?' [one investor said]. 'You just told us you didn’t need any equity.'"
PPL shares fell 3.4% to US$27.82 on the day, setting the conversion price on the CB at US$34.08, a level the stock had last traded in early 2020 or just before the onset of the pandemic.
PPL would only need to account for stock dilution at share prices well above recent highs and had the option to settle any residual value in cash, Henninger told shareholders. Moreover, the stock would have to double before the CB would dilute EPS, reducing just two to three cents annually, he said.
Rival US power utilities quickly followed suit and seized on the low-cost funding opportunity afforded by a CB. Southern Company followed two days later with a US$1.725bn 2.75-year CB priced at a 3.875% coupon and Alliant Energy a week later with a US$500m three-year CB which also priced at a 3.875% coupon.
In an industry notoriously cautious, PPL secured better terms than rival utilities and completed the first plain vanilla CB from the sector since 2003. "My only regret was not issuing more," Henninger said.
To see the digital version of this report, please click here
To purchase printed copies or a PDF of this report, please email shahid.hamid@lseg.com in Asia Pacific & Middle East and leonie.welss@lseg.com for Europe & Americas.
