Euromoney deals of the year, Asia, 2011

Euromoney, February 2012

DEALS:

Sun Art Retail Group HK$9.47 billion IPO. (Global coordinators Citi, HSBC, UBS)

Kingdom of Thailand Bt40 billion inflation-linked 10-year bonds (sole books: HSBC)

ICBC (Asia) RMB1.5 billion 6% tier-two sub-debt bonds, 10 year non-call five (HSBC, ICBC International, Bank of China HK, Credit Suisse, DBS, Goldman)

BP/Reliance $9 billion strategic partnership (advisors: Goldman, Morgan Stanley)

Vedanta Resources $6 billion acquisition financing for Cairn India with $1.65 billion bond (Barclays, Citi, Credit Suisse, Goldman Sachs, JP Morgan, Morgan Stanley, RBS, Standard Chartered)

Republic of Indonesia $2.5 billion 10-year bond (Deutsche, JP Morgan, UBS)

TEXT

If much of the world lacked bright moments in 2011, you could at least still find them in Asia – and nowhere more so than in Indonesia.

The worst laggard of the Asian financial crisis is a country transformed, which is nothing new to foreign investors: by August of this year they held 36% of all rupiah government bonds in the country before a brief but manageable pullback later in the year. Indonesia’s numbers – whether foreign exchange reserves, GDP growth, net external debt or contribution of domestic demand – provided a compelling case for an upgrade to investment grade status all year, and in December Fitch became the first of the rating agencies to give them that vital and symbolic boost. The other two agencies are expected to follow.

A large part of the reason Indonesia got there was through its masterful use of the international capital markets, which has represented the country very well on the world stage. This included an impressive sukuk deal as well as conventional issues, but the standout was a $2.5 billion 10-year bond in April. It was a deal that felt like an investment grade credit was behind it; and the pricing proved it.

The deal came at a yield of 5.1% and a coupon of 4.875%, the lowest the country had ever achieved. It attracted $6.9 billion of orders from 270 accounts, particularly Americans, who took 49% of the deal. “We really found the right timing for that deal,” says Rahmat Waluyanto, director general of debt management in Indonesia’s Ministry of Finance. “We knew the market was waiting for Indonesian paper, because of its scarcity value; we were not a very efficient user of international bonds compared to the Philippines. But it was the right time, the right issue and the right tenor, and it gave us our lowest ever yield.”

Having set Indonesia in the proper context, the deal also had a big knock-on effect. The following month, Pertamina, a state-owned oil and gas company, launched a $1 billion inaugural 10-year bond, and four days later added a $500 million 30-year tranche, capitalising on the clamour among investors for longer state-backed paper. And by November, sentiment towards Indonesia was so strong – just as the mood elsewhere was so toxic – that it was able to price a $1 billion seven-year sukuk pricing at a profit rate (like a yield) of just 4% – this at a time when Italy was having to pay 7%.

All three transactions were credible deal of the year candidates, and are best considered in aggregate as an illustration of a country finding its voice at the top table of the capital markets. Indonesia’s stock market was one of the few that went up last year; HSBC says its bond index for the country has topped 20% in three consecutive years. And if the two remaining rating agencies come through with their expected upgrade, the picture is going to get better still. “I expect that funding costs will become much lower,” says Waluyanto, “not just from the bond and sukuk markets, but in credit.” While yields have plummeted on sovereign and similar paper, they haven’t yet done so in the corporate bond space, and it’s likely that a spate of corporate issuance will come from the country this year when those yields do start to move.

Indonesia wasn’t the only sovereign to impress in 2011. Euromoney has long argued the importance of deep, liquid, sophisticated local currency bond markets in Asia, and the transaction that most clearly spelled out how much improvement has taken place came from Thailand, with a Bt40 billion inflation-linked bond that priced in July.

It’s not as if it was the easiest year for Thailand. It entered 2011 in continuing political turmoil, then had a general election with unexpected results, and was then blighted by the worst floods in its modern history. But the bond demonstrated how Thailand’s markets – stock and bond, domestic and, in terms of foreign participation in the country, international – have remained remarkably resilient no matter what happens there. Having set about a domestic education programme in May and launched domestic and international roadshows in June, the deal finally launched the week after the election.

It flew out the door, gaining Bt65 billion of orders from 65 accounts in 11 countries – quite something for a Thai baht deal. The planned B20 billion deal was doubled in size and still had room to spare. The real yield was just 1.2%, providing excellent funding to the state, while the 37.5% allocation to international investors provided a good mix of foreign enthusiasm and important local engagement.

More than that, it made Thailand the first country in southeast Asia to issue inflation-linked bonds. At that point of the year, inflation was still considered the biggest single threat that Asian central bankers had to deal with, and although problems in Europe have turned attention away from inflation and back to growth, this structure is likely to prove increasingly important in future. (The Philippines is believed to have a similar deal in the works already.) It diversified Thailand’s investor base, extended its duration to 10 years – a useful contribution to Thai bond market development too – and brought the country to global investor attention without having to take on a currency risk. The deal, said Chakkrit Parapuntakul, director general of the Ministry of Finance’s Public Debt Management Office, “raised the bar of the domestic bond market to the international level.”

In 2011, the dim sum market achieved a hectic graduation from nascent wild-west-style market to something approaching maturity and depth. The clearest illustration of this came with a RMB1.5 billion subordinated bond from ICBC Asia, owned by mainland banking heavyweight ICBC.

It was full of firsts. For a start, it was the first subordinated bond in the dim sum market, and expected to be followed by more. It was the first subordinated bond from Asia in any market to be Basel III compliant. And it brought 10 year tenor (this was a 10-year non-call-five deal) to the dim sum market, increasing its maturity.

“We had two different hurdles to overcome,” says Peter Leung, chief financial officer of ICBC (Asia). “First was obviously the marketing and selling, but even before we started that, we had to do a lot of persuading of the regulators. The HKMA was not very keen to approve this sort of structure.” So the first challenge was to convince the HKMA; only then could they talk about marketing.

The structure in question had to fit within Basel III requirements, and involved something called the non-viability loss-absorption clause. If the bank is declared unviable – which would be done by the HKMA – then the value of the bonds are written down to zero. Since the HKMA has not yet clarified the precise parameters within which this might happen, it was naturally reticent to approve a structure, yet it did so, suggesting that the ICBC format will be the one for others to follow. “One the HKMA approved, we were able to convince investors that this is exactly the sort of structure regulators will be approving from now on,” says Leung. “There’s no possibility that they will return to [old rules on] tier two deals; people have to live with it. Our explanation to potential investors was that they could keep waiting on the sidelines or look at this new structure.”

The pitch certainly worked: the book was over RMB5 billion from 83 accounts, allowing the deal to price at 6%, the tight end of guidance, which was more than agreeable for an issuer in a market that had no experience of 10-year paper, nor of sub debt, and which was being knocked about by problems in Europe. Better still, it then traded up in the days after launch, just as dollar bonds were widening.

Investors were clearly reassured by the fact that the issuer is backed by, on some measurements, the largest bank on earth, and were therefore deeply unlikely to find themselves cut off. “ICBC Asia would be closing down in Hong Kong from the moment the loss absorption came into place,” says Leung. “It would mean all the investment, including the money that has been spent to privatise our bank, would go down the drain. It’s not even worth talking about this sort of risk coming into effect.”It’s likely to be the other big banks and their subsidiaries that take this route in the near term.

While the timing in early November looked hideous, Leung says it worked out well. “We found quite a sweet spot on it,” he says. “It was a time when some investors from China were keen to move their wealth overseas, but initially wanted to buy into some quality issuers in CNH. They were also getting fed up of the dim sum market because of questions on issuer quality.” Bringing a high quality issue with a good yield was just what investors wanted to see.

Despite challenges in credit markets, there was still room for innovation and scale in Asian high yield, with the standout deal coming from India. This came as part of Vedanta Resources’ takeover of a stake in Cairn India, a process that began in 2010 and required a swift raising of $6 billion of capital; this started out as a $3.5 billion term loan, a $1.5 billion bridge-to-bond deal and $1 billion bridge-to-equity. By the time it became clear that the deal was going to go through, Vedanta sought to take out the bridge-to-bond bit, and did so with a $1.65 billion bond that became India’s biggest corporate bond to date, and the largest true corporate (that is, not a government body) from anywhere in south or southeast Asia.

The numbers themselves are impressive: a five year $750 million bond at 6.75% and a 10-year $900 million tranche at 8.25%. But the circumstances were also challenging. Ideally launching the bond would wait until there was some certainty on the deal going ahead, but it took almost a year for the government to approve it. “At times it was a peculiar process,” recalls Ashish Garg, vice president of corporate finance at Vedanta. “We were actually on the road to market the bond although we didn’t have any confirmation, or even an indication from the government that the approvals would come and on what conditions – something to go into the document as a confirmation.” Lacking that, the company and lead managers had to spell out what the alternate use of funds would be if the deal did not go through. All due diligence and disclosures had to include the target even when it was not yet a part of the group; the company was on rating watch negative because of the scale of the acquisition; and to do a 144a deal, pro forma accounts for the consolidated company were required for the previous 12 months, yet access to those accounts was not possible. “We had to pick and choose and arrive at a combination of what was available to present to investors. There was a lot of work with banks, lawyers and accounts to come to a mutually agreed position on what could be accepted to take this transaction to market.”

Despite all that, the deal went well. A final order book reached $4.5 billion, with 210 investors in each tranche. Investors worldwide took part, with 38% of the deal going to the US and 32% to Europe on the five year, 47% and 37% on the 10. How? Partly it was about the company and the sector; Vedanta is one of the world’s fastest growing mining companies, with an EBITDA compound annual growth rate of 41% over the last seven years, and brings exposure to India, Australia, Zambia, Namibia, South Africa and Ireland in one London-listed company. Its entry into oil and gas through Cairn also appealed. There was also a sense that the acquisition itself was significant, “not because of the size but the characteristics of the transaction: an Indian group acquiring an Indian asset from an overseas operator,” says Garg. He also feels that the company is likely to rise from its Ba1/BB/BB+ rating today to investment grade once the Cairn cashflows start to kick in. “We firmly believe one or two years down the line, reflecting growth and projects being completed and generating cashflows, the rating of the company should move to investment grade,” says Garg.

Good deals were rather harder to find in the equity world, but they were out there, and a natural standout was Sun Art Retail Group, whose $1.2 billion IPO achieved the rare double act of being good for both issuer and investors. Most deals declined, even tanked; Sun Art priced at HK$7.20 in July and at the time of writing was trading at just under HK$10.

But this wasn’t a case of leaving money on the table: the deal priced at the top of its range, 32 times forecast 2011 earnings. So what went right?

“At the time we did the IPO, the market was quite unstable,” recalls Jean Patrick Paufichet, CFO of Sun Art. “In the beginning of June we tested some investors and made a decision to allocate a big part of the deal to cornerstones, because we realised they were very interested in the company in the long term.” Eventually 40% of the deal would go to cornerstones, attracted by the growth prospects of the hypermarket chain in China, and the sites it had secured for development. “The cornerstones showed the way to the investment community, and after that it was easier to get interest,” Paufichet says.

“Then I think we priced at the right level. Compared to our peers we were a little bit over, but not too much,” he continues. “We were the only pure hypermarket player listing in Hong Kong, and pure Chinese, so there was a lot of interest in us.” Sun Art was the only consumer retail deal of scale all year from this part of the world; chat about “the Wal-Mart of China” didn’t hurt either.

It wasn’t plain sailing, though. The whole IPO had to be delayed after an error arose in the prospectus, requiring a supplementary prospectus to be issued and for all investors to reconfirm their orders. Most did, and their experience was one of the few positive ones in the Asian stock markets in 2011.

Finally, to M&A, where the standout transaction was the $9 billion strategic partnership between BP and Reliance. This wasn’t a landmark takeover, since there was no overall change of control – instead Reliance Industries sold a 30% stake in its southern and eastern Indian oil and gas fields to BP, for $7.2 billion plus up to $1.8 billion in performance payments. But partly through scale – one of the biggest FDI deals into India – and partly through the sheer effort of getting any inbound deal over the line in India, it warrants recognition.

Needless to say this was not a swift transaction. Three government ministries, a cabinet panel and the prime minister had to sign off on it, a process that took the best part of half a year. But for BP, this was worth waiting for. Most publicity around the company in recent years has involved the Gulf of Mexico spill, the costs of clean-up, and the associated divestments; a major purchase like this in an emerging market basin puts it back on the front foot again. Reliance gets expertise, particularly in deep sea drilling; its fields are deep and it needs help to exploit them effectively. There’s also a JV that comes out of this deal to sell LNG, and with it should come much-needed infrastructure development.