E-bonds: Will They Fly?

Internet bond auctions can help corporate issuers lower their cost of capital. But savings from lower sales and marketing costs may not be as great as you might imagine.

Last August, when U.S.-based Dow Chemical (www.dow.com) became the first non-financial corporation to sell its bonds directly to investors through a Web-based Dutch auction, it was hailed as a watershed event in the investment banking world. The businesses of securities brokerage and trading had already been revolutionized by online brokers and electronic communication networks. Wall Street’s most lucrative franchise, the control of new-issue distribution, was next. And corporate issuers could expect to reap the benefits of lower transaction costs and better prices for their securities.

Why then, seven months later, is Dow still the only industrial corporation to conduct an online bond auction? Two words: bear market. Thanks to widening spreads on corporate bonds, raising debt capital was a difficult proposition online or off in the second half of last year. And corporate issuers decided that in a bad market, they were better off with Wall Street underwriters pricing the deal, rather than the open market. “There is a fear among issuers that in a weak market, the transparency of online pricing might work against them,” explains Ralph Cioffi, senior managing director at Bear Stearns in New York.

Maybe so, but it’s hard to argue with the success of Dow’s online auction. The company raised $300 million in five-year bonds using software developed by San Francisco-based investment bank WR Hambrecht. The auction drew a far broader investor base than usual, and every successful bidder walked away with a full allocation. Dow is paying about the same interest rate it would have paid had it taken the traditional syndicate route, and it had to cough up less than half the typical underwriting fee. “To me, it’s a no-brainer,” says Dow treasurer Geoffery Merszei.

It did, however, take some courage on Dow’s part. Wall Street banks stand to lose a lot of power and revenue if they relinquish control of new-issue distribution, and they’re not above fighting to save their bread and butter. Undoubtedly, plenty of corporate issuers will decide that a few basis points aren’t reason enough to damage relationships with their investment bankers. But in the long run, Internet bond auctions, particularly for plain-vanilla investment-grade debt, could save corporate issuers a significant amount of money.

E-Bonds and Dutch Auctions

The first corporate bond billed as an “Internet bond” or “E-bond”, was issued by Ford Motor Credit (www.fordcredit.com) in early 2000. The $1 billion offering of three-year notes worked much like a traditional bond underwriting, except that the prospectus and other marketing materials were posted on the Web, and orders were taken by email. The issue, however, was still priced by the lead manager, Lehman Brothers (www.lehman.com), not by the investors that ultimately bought the bonds.

Over the next three quarters, a handful of other Internet bond offerings followed, with issues by DaimlerChrysler, the World Bank and BASF, and, later in the year, by Bear Stearns, Deutsche Bank and, ultimately, Dow. While these offerings were all billed as E-bonds, the last three were the only issues priced and allocated through online Dutch auctions.

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