Treasury policies
The boards of Reed Elsevier PLC and Reed Elsevier NV have requested that Reed Elsevier Group plc and Elsevier Reed Finance BV have due regard to the best interests of Reed Elsevier PLC and Reed Elsevier NV shareholders in the formulation of treasury policies.
Financial instruments are used to finance the Reed Elsevier businesses and to hedge transactions. Reed Elsevier’s businesses do not enter into speculative transactions. The main treasury risks faced by Reed Elsevier are liquidity risk, interest rate risk, foreign currency risk and credit risk. The boards of the parent companies agree overall policy guidelines for managing each of these risks and the boards of Reed Elsevier Group plc and Elsevier Finance SA agree policies (in conformity with parent company guidelines) for their respective business and treasury centres. These policies are summarised below.
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Liquidity
Reed Elsevier maintains a range of borrowing facilities and debt programmes to fund its requirements, at short notice and at competitive rates. The significance of Reed Elsevier Group plc’s US operations means that the majority of debt is denominated in US dollars. A mixture of short term and long term debt is utilised and Reed Elsevier maintains a maturity profile to facilitate refinancing. Policy was amended in 2008 to provide more flexibility to respond to investor demand and fund at attractive rates and requires that no more than US$1.5bn (formerly US$1.0bn) of term debt issues should mature in any 12-month period. In addition, minimum levels of borrowings with maturities over three and five years are specified, depending on the level of net debt.
From time to time, Reed Elsevier may repurchase outstanding debt in the open market depending on market conditions. No such purchases were made in 2008.
In March 2008, Reed Elsevier signed a new US$4,350m committed loan facility with a syndicate of banks to finance its acquisition of ChoicePoint, Inc., subsequently cancelled down to US$4,207m in July 2008, comprising US$2,032m maturing in March 2010 (Tranche A) and US$2,175m maturing in March 2011 (Tranche B). The full US$4,207m was drawn down on completion of the acquisition in September 2008. Following the successful issue of US$1,500m of term debt in the US market and a €50m term debt issue in January 2009, Reed Elsevier used the proceeds to reduce Tranche A to US$470m.
During October 2008, following the turbulence in the banking and credit markets, there was uncertainty in demand for commercial paper. Whilst Reed Elsevier continued to access the US commercial paper market throughout the period, the uncertainty in demand for euro commercial paper was mitigated by drawing down under existing bank back up facilities for one month in an amount of US$461m in aggregate. These back up facility borrowings were repaid in November as investor demand for euro commercial paper returned.
At 31 December 2008 gross borrowings after fair value adjustments amounted to £6,142m and the fair value of related derivative assets was £41m. Cash and cash equivalents totalled £375m, of which £345m was held on deposit with banks rated A+ or higher by Standard and Poor’s, Moody’s, or Fitch.
At 31 December 2008, in addition to the fully drawn ChoicePoint facility, Reed Elsevier had access to US$3.0bn (2007: US$3.0bn) of committed bank facilities, of which US$38m was drawn. These facilities principally provide back up for short term debt as well as security of funding for future acquisition spend. These committed facilities expire in May 2010.
During February 2009, Reed Elsevier cancelled this US$3.0bn facility down to US$2.5bn and, at the same time, a new US$2.0bn committed bank facility, forward starting in May 2010 and maturing in May 2012, was put in place. Together these two back up facilities provide security of funding for US$2.5bn of debt to May 2010 and US$2.0bn of debt from May 2010 to May 2012.
After taking account of the maturity of committed bank facilities that back short term borrowing and after utilising available cash resources at 31 December 2008, no borrowings mature in the next twelve months, 31% of borrowings mature in the second year, 33% of borrowings mature in the third year, 12% in the fourth and fifth years, 16% in the sixth to tenth years, and 8% beyond the tenth year. Allowing for the US$1.6bn term debt issued in January and the US$2.0bn forward start facility, no borrowings mature in the next two years, 21% of borrowings mature in the third year, 36% in the fourth and fifth years, 23% in the sixth to tenth years, and 20% beyond the tenth year.
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Interest rate exposure management
Reed Elsevier’s interest rate exposure management policy is aimed at reducing the exposure of the combined businesses to changes in interest rates. The proportion of interest expense that is fixed on net debt is determined by reference to the level of net interest cover. Reed Elsevier uses fixed rate term debt, interest rate swaps, forward rate agreements and a range of interest rate options to manage the exposure. Interest rate derivatives are used only to hedge an underlying risk and no net market positions are held.
At 31 December 2008, after taking account of interest rate and currency derivatives, US$7.0bn of Reed Elsevier’s net debt was denominated in US dollars and net interest expense was fixed or capped on approximately US$4.2bn of forecast US dollar net debt for the next 12 months. In January 2009 a further US$1.5bn of fixed rate US dollar debt was issued, replacing floating rate US dollar debt, and increasing the amount of US dollar debt on which net interest expense is fixed or capped to approximately US$5.7bn. This fixed or capped net debt reduces to approximately US$3.8bn by the end of 2011 and reduces further thereafter with all but US$0.7bn of fixed rate term debt (not swapped back to floating rate) having matured by the end of 2019.
At 31 December 2008, fixed rate US dollar term debt (not swapped back to floating rate) amounted to US$2.2bn (2007: US$1.2bn) and had a weighted average life remaining of 9.5 years (2007: 8.1 years) and a weighted average interest rate of 5.4% (2007: 5.9%). After the issuance of a further US$1.5bn of US dollar term debt in January 2009, fixed rate US dollar term debt (not swapped back to floating rate) amounted to US$3.7bn and had a weighted average life remaining of 9.0 years and a weighted average interest rate of 6.6%. Interest rate derivatives in place at 31 December 2008, which fix or cap the interest cost on an additional US$1.6bn (2007: US$1.1bn) of variable rate US dollar debt, have a weighted average maturity of 1.8 years (2007: 1.1 years) and a weighted average interest rate of 4.6% (2007: 4.8%).
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Foreign currency exposure management
Translation exposures arise on the earnings and net assets of business operations in countries other than those of each parent company. These exposures are hedged, to a significant extent, by a policy of denominating borrowings in currencies where significant translation exposures exist, most notably US dollars.
Currency exposures on transactions denominated in a foreign currency are required to be hedged using forward contracts. In addition, recurring transactions and future investment exposures may be hedged, within defined limits, in advance of becoming contractual. The precise policy differs according to the specific circumstances of the individual businesses. Expected future net cash flows may be covered for sales expected for up to the next 12 months (50 months for Elsevier science and medical subscription businesses up to limits staggered by duration). Cover takes the form of foreign exchange forward contracts.
As at 31 December 2008, the amount of outstanding foreign exchange cover designated against future transactions was US$1.6bn (2007: US$1.4bn).
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Credit risk
Reed Elsevier seeks to limit interest rate and foreign exchange risks described above by the use of financial instruments and as a result has a credit risk from the potential non performance by the counterparties to these financial instruments, which are unsecured. The amount of this credit risk is normally restricted to the amounts of any hedge gain and not the principal amount being hedged. Reed Elsevier also has a credit exposure to counterparties for the full principal amount of cash and cash equivalents. Credit risks are controlled by monitoring the credit quality of these counterparties, principally licensed commercial banks and investment banks with strong long term credit ratings, and the amounts outstanding with each of them.
Reed Elsevier has treasury policies in place which do not allow concentrations of risk with individual counterparties and do not allow significant treasury exposures with counterparties which are rated lower than A by Standard and Poor’s, Moody’s or Fitch.
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Capital management
The capital structure is managed to support Reed Elsevier’s objective of maximising long-term shareholder value through ready access to debt and capital markets, cost effective borrowing and flexibility to fund business and acquisition opportunities whilst maintaining appropriate leverage to optimise the cost of capital.
Over the long term Reed Elsevier targets cash flow conversion (the proportion of adjusted operating profits converted into cash) and credit metrics to reflect this aim and that are consistent with a solid investment grade credit rating. Levels of net debt should not exceed those consistent with such a rating other than for relatively short periods of time, for instance following an acquisition. The principal metrics utilised are free cash flow (after interest, tax and dividends) to net debt, net debt to ebitda (earnings before interest, taxation, depreciation and amortisation) and ebitda to net interest. Cash flow conversion of 90% or higher and a net debt to ebitda target, over the long term, in the range of 2x to 3x are consistent with the rating target.
Reed Elsevier’s use of cash over the longer term reflects these objectives through a progressive dividend policy, selective acquisitions and, from time to time when conditions suggest, share repurchases whilst retaining the balance sheet strength to maintain access to the most cost effective sources of borrowing and to support Reed Elsevier’s strategic ambition in evolving publishing and information markets. Over the next 12-18 months the focus is on the repayment of debt out of cash flow and to restore Reed Elsevier’s credit ratios to more usual levels.
The balance of long term debt, short term debt and committed bank facilities is managed to provide security of funding, taking into account the cash generation of the business and the uncertain size and timing of acquisition spend.
Whilst the short term emphasis is on reducing leverage, there were no changes to Reed Elsevier’s long term approach to capital management during the year.