(Corrects paragraph 15 to show that Schaeffler will not use proceeds for a dividend)
* Schaeffler preps EUR1.5bn-equivalent five-year PIK toggle
* Deal will be biggest PIK toggle in either euros or dollars
* Bond to give flexibility ahead of larger reorganisation
By Robert Smith
LONDON, July 17 (IFR) - German car parts supplier Schaeffler is aiming to issue the largest payment-in-kind toggle on record that will give it greater financial flexibility as it eyes a wider reorganisation.
Schaeffler announced plans for the EUR1.5bn-equivalent deeply subordinated bond on Wednesday, and is expected to price the dual-tranche deal on Friday following investor meetings in London today and in the US on Thursday.
The currency split is expected to be roughly equal, which will make it the largest in both the euro and dollar markets, according to one banker on the deal.
The five-year senior secured note, expected to be rated B2/B-, will be used to refinance existing holding company debt, and will rank pari passu to other secured indebtedness at Schaeffler Verwaltungs GmbH - the holdco business.
The PIK toggle is part of a wider EUR3.875bn refinancing, in which EUR2.175bn of term loans and a EUR200m revolver have been agreed with banks, and is part of the company's strategy to refinance more of its leveraged loans with bonds.
Schaeffler intends to pay the coupon in cash for the life of the bond, but does have the option to toggle, which means it could allow the interest to accrue on the principal, under two very specific circumstances: if there is less than EUR1bn of liquidity at Schaeffler's operating company, or less than 10% headroom under the opco's maintenance covenants.
Deutsche Bank and JP Morgan are joint bookrunners and left leads on the euro and dollar bonds respectively, while BNP Paribas, Citi, Commerzbank, HSBC and UniCredit are also joint bookrunners.
The deal, if successful, will be the first bond issued out of Schaeffler's holding company and the first PIK toggle to print in euros since May 2.
Importantly, the relatively short call period on the instruments will give the company the option of refinancing the debt after one year without incurring harsh penalties.
Schaeffler has made no secret of its aim to reduce holdco debt, and the main ways it could achieve this are by selling more Continental shares, selling a stake in the opco Schaeffler AG, or listing it on the stock market.
Schaeffler has a 49.9% stake worth over EUR11bn in German tyre maker Continental.
"They are not committed to any particular option, but the fact they were willing to pay for the short call protection is a signal they want to do something sooner rather than later," the banker said.
PIK toggles have only just emerged in Europe this year, with four borrowers - Kloeckner Pentaplast, Orange Switzerland, R&R Ice-Cream and Sunrise - printing deals.
PIKs are considered to be risky instruments because of their deep subordination and low recovery rates in the event of a default. Schaeffler's PIK, however, is set apart from its predecessors, which may help it achieve attractive pricing.
In contrast to the majority of PIK toggles, Schaeffler will not use the proceeds to fund a dividend distribution, while the company's intention to pay cash coupons will be another strong selling point.
Schaeffler's deal will also have much stronger collateral as it will be secured on the shares of the Schaeffler AG opco. Opco security is not a typical feature of PIK toggles.
The PIK will give Schaeffler greater flexibility in the event of a downturn, and will also lessen the constraints from maintenance covenants on the leveraged loans the PIK is refinancing.
"The opco refinancing limited the amount of cash that can be sent up to the holdco," said the banker.
"There's more than enough room to keep sending cash upstairs, so the toggle is just a safety feature in the event of the unexpected."
The PIK's direct security on a 14% of Continental AG is another favourable characteristic.
Schaeffler was left holding 90% of Continental's shares after a tender offer launched in 2008 coincided with the collapse of Lehman Brothers and a sharp drop in global equities.
The timing meant that Schaeffler paid over the odds, and the four original underwriters of the acquisition debt were left holding it until last year.
Schaeffler has turned itself around since then, establishing a strong foothold in the bond market following its debut in February 2012 with a EUR2bn-equivalent deal that has performed well in the secondary market.
Schaeffler has a strategy to refinance its considerable bank debt pile, which has historically constrained the credit rating of Continental.
Continental tapped the high yield bond market last week, printing a EUR750m five-year deal on July 9 with a semi-annual coupon of just 3%.
On July 15, Fitch upgraded Continental's long term IDR to BBB, from a sub-investment grade BB rating. This is because Fitch now deems the linkage between Schaeffler and Continental weak enough to rate Continental on a stand alone basis, whereas it was previously constrained by Schaeffler's rating. (Reporting by Robert Smith, editing by Julian Baker, Natalie Harrison, Alex Chambers)