# Analysis of TenneT's Optimal Hybrid Bond Utilization

## Current Capital Structure (as of 2023-01-01)

**Adjusted Capital Components:**
- Long-term Borrowings: €19,006M
- Current Borrowings: €709M
- **Total Debt: €19,715M**
- Equity Attributable to Owners: €7,258M
- Hybrid Capital: €2,125M (already outstanding)
- **Total Adjusted Capital: €29,098M** (debt €19,715M + equity €7,258M, excluding hybrid)

**Current Hybrid Ratio:**
- Hybrids as % of Adjusted Capital: €2,125M / €29,098M = **7.3%**
- Well below the 15% S&P cap

## Financial Performance Analysis

**Profitability Concerns:**
- 2022 Net Loss: €879M (consolidated)
- 2023 Loss Attributable to Equity Holders: €967M
- Operating Loss 2023: €976M
- The company is operating at significant losses despite €8.3B in revenue

**Leverage Metrics:**
- Debt/Equity Ratio: 2.71x (19,715 / 7,258) - very high
- Debt/Total Capitalization: 73.1% - heavily leveraged
- Interest Coverage: Highly negative due to operating losses
- Long-term Borrowings increased 53.6% YoY (€12.4B → €19.0B)

## Market Conditions in 2022

**Interest Rate Environment:**
- 5Y Swap: 1.726% average (up sharply from -0.264% in 2021)
- 7Y Swap: 1.806% average
- 10Y Swap: 1.927% average
- **Significant rate increase environment**

**Credit Spreads:**
- Corporate bond spreads widened substantially in 2022
- EUR IG spreads approximately 225 bps on average (iShares + swap spreads)
- Subordinated spreads approximately 295 bps (delta 0.2 premium)

**Cost of Debt:**
Finance Costs 2022-2023: €300M on ~€19.7B debt ≈ 1.52% blended rate (likely reflects prior period locks)

## Key Considerations

**Disadvantages of Higher Hybrid Utilization:**

1. **Current Financial Distress**: Operating losses, negative cash flow from operations, substantial write-downs, and a deferred tax asset of €711M (suggesting recent losses)

2. **High Leverage**: Already at 2.71x debt/equity with increasing absolute debt levels. Higher leverage increases financial risk significantly

3. **Market Conditions**: 2022 saw a sharp rise in interest rates and credit spreads, making hybrid issuance more expensive

4. **Regulatory/Rating Pressure**: With €967M equity losses in 2023, rating agencies may be concerned about equity quality. The 15% cap exists for a reason—to limit hybrid dependency

5. **Equity Deterioration**: Equity grew modestly (€7.258B vs €6.969B) primarily through capital contributions (€1.23B), not retained earnings. This suggests weak organic equity generation

6. **Hybrid Characteristics**: While hybrids provide some equity credit, they still carry debt-like obligations that could strain cash flow in continuing difficult operating conditions

**Mitigating Factors:**

1. **Regulated Utility**: TenneT is a transmission system operator (regulated monopoly) with stable revenue (€8.3B in transmission charges)

2. **Headroom Below Cap**: Currently at only 7.3% of the 15% S&P cap, suggesting ratings agencies would permit higher levels

3. **Capital Requirements**: The company is investing heavily (€4.4B capex in 2022-2023) for grid modernization and transition

## Conclusion

While TenneT has technical capacity to use more hybrids (only 7.3% vs 15% cap), the company's current financial distress argues against maximizing hybrid utilization. The recent shift to operating losses, high leverage, and rising refinancing costs suggest TenneT should exercise **conservative** capital management.

The company should maintain hybrids at current levels for refinement purposes but avoid aggressive expansion. The losses and leverage trajectory indicate priority should be placed on:
- Improving operational profitability
- Managing total leverage
- Preserving equity through retained earnings recovery
- Securing equity capital contributions (as occurred in 2023)

Rather than approaching the 15% cap, prudent management suggests maintaining hybrids at approximately 1/3 to 1/2 of the permissible cap level.

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