From the January 2011 issue of Investment Advisor • Subscribe!

Revolution and Reform

France’s trouble with retirement reform has done little to sway investors away from the country

For weeks, news stories about strikes and protests in France over President Nicolas Sarkozy’s unwavering decision to change the country’s pension system dominated the headlines. Students took to the street like it was 1968, cars burned and thousands vented their fury over the impending changes.

But surprisingly, the furor did nothing to deter investor interest over France. On the contrary—and notwithstanding all that happened in the country itself—in a year when Europe has barely had a chance to catch its breath between the different sovereign crises that have threatened its very existence, France has actually stood out from the pack and its fixed income markets have proven themselves a safe haven in the Eurozone on several occasions this year.

[Read about France's struggle with pension reform.]

Most recently, French sovereign bonds were the beneficiaries of the flight to quality that occurred following the announcement of a $113 billion joint European Union and International Monetary Fund (IMF) bailout for Ireland, and through the year, French investment-grade corporates have also been an attractive and important part of the corporate bond market in Europe. But even at the height of the financial crisis in 2008 and 2009, demand for French bonds was high, and the first company to approach the pound sterling bond market after the collapse of Lehman Brothers, says Emmanuel Teissier, fixed income strategist at Franklin Templeton Investments, was GDF Suez, a leading French utility with a cutting edge business.

“Although French banks are in fairly good shape, they have pushed companies to approach the bond market to replace their bank facilities,” Teissier says. “That trend is not specific to France only, of course, and has been observed in many developed countries since Lehman collapsed, [but] as a result, new French companies have approached the bond market for the first time over the last two years.”

According to Tim Hall, global head of debt capital markets origination at French bank Calyon in London, the biggest French bond story is the advent of sub-investment grade issuers from France and the use they have made of the capital markets. Like their investment-grade counterparts, French high-yield issuers have realized the benefits of having both bank and bond debt on their balance sheets, Hall says, and this year the European bond markets have seen a significant number of high-yield issues—euro as well as dollar-denominated—from French corporates, almost all of which have been well received by enthusiastic investors. The list includes specialty chemical companies Rhodia and SNF Floerger Group; spirits company Remy Cointreau; car rental concern Europcar and auto giant Renault.

High-yield bonds were also a part of the funds that financed the $2 billion buyout of French frozen food company Picard by private equity firm Lion Capital, one of the few European leveraged buyouts (LBOs) this year and the biggest such deal in France since 2008.

All these bond issues did very well—in fact, Hall says, Remy Cointreau’s $272.7 million issue, which came to market in June, was well oversubscribed. “The combined benefits of Remy as an infrequent issuer, the relatively small transaction size, the company’s strong brand recognition and the non-cyclical nature of the business attracted strong investor interest, thereby enabling the bonds to price with an attractive coupon of 5.18% based on a book that was three times oversubscribed,” he says. “And although SNF is a privately held company, its $252.7 million, 8.25% bond was also very well received, largely because the company was able to weather the financial crisis with minimal deterioration in its operating performance in spite of the cyclical chemicals sector in which it operates.”

High-yield issues out of France are still a small part of overall corporate bond issuance, but fixed-income investors—whose risk appetite has been fairly strong this year—like them very much. Many French companies have been able to borrow at competitive rates, says Richard Hunter, managing director for corporate bond ratings at ratings agency Fitch Ratings in London, and firms like Renault and Peugeot, which are rated sub-investment grade but are regarded as blue-chip corporates, have been able to issue bonds on the same covenant-free terms as their investment-grade counterparts.

“Theoretically, this gives investors less protection, but it hasn’t hurt those issuers’ ability to raise debt,” Hunter says. “What’s most interesting about the recent wave of French high-yield bond issues is the relative comfort level of investors vis-à-vis the legal jurisdiction in France. Our loss severity ratings for issuers in France, unlike in Germany and the U.K., are capped to reflect the less ‘creditor-friendly’ nature of the legal regime, with more priority given by courts to supporting the issuer’s management and less priority to legal seniority of debt, but the need for yield has evidently offset investors’ reluctance on that front.”

According to Curtis Lyman, Palm Beach, Fla.-based managing director and partner of HighTower Advisors, France has been making greater strides in terms of transparency and disclosure, and in protecting junior creditors in French bond deals, and this is also encouraging investors. This year’s high-yield bonds have been issued using innovative structures in senior secured notes and junior priority notes, he says, and as French companies continue to diversify their funding sources, the innovation will continue.

Yet innovation is not new to the French corporate world: While there is a general perception of France as a country where deep-rooted social initiatives have resulted in serious government overhang, the private sector is and always has been a space apart, functioning as a highly sophisticated mechanism that investors the world over respect for its well-managed operations.

“France has many good companies—some solely domestic, some ‘national champions’ and some very strong global players—so the demand from investors for bonds issued by French companies has been and continues to be very strong,” Calyon’s Hall says.

Investment-grade companies from France have always been skilled users of the capital markets, says Fitch Ratings’ Hunter, and they borrow money on a regular basis to fund their business needs. Investors are used to seeing companies in the infrastructure and energy sectors, and have been long-time lenders to names like Total, Electricite de France and SNCF. These companies have regular financing needs, they are strong A- or higher-rated credits, they have a good story to tell, and this year, issuers from a lot of new sectors, including consumer goods, have joined them, he says.

Most French companies clearly recognize the benefits of including the bond market as part of their debt capital structure, and experts believe that this reliance on a broader creditor base, which in turn leads to greater creditor diversity, is a wise financing strategy over the long term. It also sets France apart from Germany (another European safe haven), says Ed Farley, head of international investing at Prudential, where companies get most of their funding from the state-owned Landesbanks—which have had to scale back their operations this year, thereby leaving more room for greater lending by private banks and capital market funding.

Like Germany, France also has a deep-rooted and fairly stable banking system, Farley says, but French corporates have always used the capital markets to their advantage, and this year have been welcome issuers because of France’s safe-haven status.

Nevertheless, France and the French corporate sector are not immune to the Eurozone’s sovereign troubles, which don’t look to be ending any time soon.

“Sovereign risk is everything,” Farley says, “and the trading levels of corporate bonds will be dictated by what is happening at the moment with Ireland and what will happen with Portugal, and how the European Union will stop the rot before it gets to Spain. French bonds have enjoyed the benefits of the country being a relative safe haven, but while bailing out Ireland, Greece and Portugal is still affordable, things get too large when you get to Spain, and even more unsustainable if Italy has to be bailed out as well.”

French corporate issuance is not exempt from deterioration in the broader credit markets, brought on by each wave of crisis in the Eurozone peripheral markets, Hall agrees, but French investment-grade borrowers are still in a relatively good position because they are well-funded (most of them were able to pre-fund in 2009, when market conditions were far better), and they can afford to sit out the choppy markets to wait for better conditions. In the high-yield universe, though, the need to diversify the creditor base and include more bond investors has a much more immediate tone, he says, which is why European high-yield volumes are likely to increase in 2011.

Overall, the outlook for high-yield debt in Europe is positive, not least because European banks remain extremely careful lenders. Investor appetite should also remain strong despite the ongoing sovereign story in Europe, but while this certainly does pose a challenge to corporates, French companies included, the greatest challenge they will have to face will be generating growth, says Hunter, and at the individual company level, this is what is going to matter the most for future funding and for attracting investors.

“Given the low growth rates we forecast for Europe, French corporates, in common with most other established Western companies, will be tempted to make further acquisitions in emerging market countries like India and China, in the hunt for top-line growth,” he says.

But even though the challenging macroeconomic environment in Europe generally and in France more specifically does weigh on profitability at the local level, French companies continue exhibiting strong operating performance and solid financial health, says Teissier. As far as the top line is concerned, sales growth is mainly driven by international operations and more than 50% of sales reported this year by the 40 biggest French market capitalizations come from outside France, he says.    

Savita Iyer-Ahrestani is a freelance writer and regular contributor to Investment Advisor and AdvisorOne.com based in New Jersey.

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