Core Projects revives Indian convertibles

IFR Asia – ECM special report, June 2010

It seems a long time ago that the markets were swamped with Indian convertible bonds: zero coupons, tightly priced with the fees squeezed til they hurt. That glut of convertibles came to an end in 2008 and there’s been little sign of it since – until a little-known Indian education company called Core Projects & Technologies reopened the market in April.

Core Projects is not an obvious name to revitalise the Indian CB market: it is a mid-cap with a market capitalization of about US$500 million, and is pretty much unknown to international investors. But in April it raised US$60 million in a five-year offshore convertible, sole lead managed by Standard Chartered.

Explaining how it came together, Standard Chartered’s global head of equity-linked solutions, Nathan McMurtray, starts by differentiating it from the 2007 explosion of convertibles. Those deals were driven by hedge funds and in particular those focusing on convertible arbitrage strategies, he says. “They were becoming increasingly dominant in convertible bond product,” he says. “They tend to be the least price sensitive and the most willing to give a company favourable terms, which is what calls the shots at the later stages of a bull market. They largely pushed strategic equity and debt investors to the sidelines.”

This worked for Indian deals so long as there was a strong equity story, with a lot of potential upside, but as the financial crisis kicked in this group of buyers – who had been heavy on leverage – were squeezed even more than other investors as banks and prime brokers withdrew funding. Regulators in India were making it progressively more difficult to sell stocks to hedge exposure, and on top of that volatility and credit spreads started to soar. “Suddenly you had a lot of pressure on a strategy that was successful to that point but optimised to a market that no longer existed,” McMurtray says.

And so the market shut down for two years. What’s brought it back is the resurgence in Indian equity markets and a levelling of credit spreads. “That started to create conditions where you could take a straight equity or credit view. When you factor in the return of equity and credit investors who had largely been sidelined, the result was people who could put a value on that equity and credit came back into the market and have begun to dominate it.” Many big straight debt and equity deals have come out of India this year, but in Core Projects Stanchart saw something different: “an opportunity for a solid business in a really good sector, but which doesn’t have an analyst following, to come to the attention of investors.” A non-deal roadshow was organised, and then the deal was attempted.

It wasn’t particularly cheap funding: the deal priced with a 7% coupon, the generous end of marketing, and a 10% conversion premium. They were sold at 900 basis points over Libor. It was a long way from the zero-coupon deals with huge conversion premiums from 2007, but then again the world looks very different today.

In any event, the terms were hardly the point so much as the fact that an Indian convertible had once again found investors. For a small deal, it went to a lot of accounts: more than 20, in Asia and Europe, including pure equity players and hedge funds. “We had to cut people back: nobody got their full order,” McMurtray says.

Will there be more? “I think there will be increasing amounts of issuance out of India, from this size to much larger ones,” he says. “During the crisis in Europe India has come through with much less effect generally on the credit and equity markets than other places in the region.” Some of that may be high yield, but regulatory restrictions which set a maximum yield that can be charged on a debt instrument make that tricky to do. “I think it will be predominantly convertible bonds.”

Others are less certain. “You need to have a view that the equity is undervalued and be able to sell that to the market to get convertibles away,” says one senior banker. “The market values are even more in India now than they were when you saw the rush of issuance. But there is an argument you could see CBs pick up first because they have a lower headline yield, and that gets you through some of the regulatory hurdles that hit a standard bond deal.”