Euroweek debt capital markets, December 9 2011

Euroweek, December 9 2011

TENCENT

Chinese internet group Tencent Holdings completed a $600 million deal this week – the first internet company from anywhere outside the US, never mind China, to sell a dollar bond – in a transaction that was impressive for being completed in a difficult market, but baffling for its timing.

The issue of five-year bonds priced at 375 basis points over Treasuries, the tight end of 375-387.5 guidance, but widened significantly after launch.

Tencent is an interesting and exciting company. While the sense of ‘China’s Google’ has proven an appealing draw in the equity markets, Tencent is actually a more diversified group, earning roughly half of its revenue from online gaming and being particularly well known for an online instant messenger product, QQ, with over 700 million subscribers – not far short of Facebook’s subscriber base. A search engine is a large part of the company’s potential, but advertising represents only 7% of Tencent’s revenue compared to over 20% for Google. “There is a huge captive audience already, and the company will look forward to better synergies between product lines,” said someone familiar with the company.

None of that is in doubt, but few in the market could understand quite why a cash-rich internet company, a debut borrower, in an uncharted sector, would pick this of all markets in which to launch a bid for non-essential funding. “It was never clear to me why an internet company needs that much money,” said one banker, not on the deal. “They wanted $750 million [believed to be the initial target] for what exactly? General corporate purposes was the stated use of proceeds, but I don’t get that.”

Those close to the deal agreed the need for funding was not obvious, but said it makes sense in the context of global peers. “These companies are typically incredible cash rich,” said one. “Microsoft did its debut bond in 2009”, whenit had $25.3 billion in cash and short-term investments. “Bill Gates was asked why he was issuing, and he said as a tech company you prefer to have loads of cash on the balance sheet.” Google, similarly cash-rich, has also issued. “It’s the same reason Tencent is doing this: there is a rates environment that offers them the opportunity to lock in funding at a compelling coupon.” This banker also noted that Tencent has operations offshore – it has bought businesses in Thailand, for example, and has operations in India – and the movement of cash offshore from China is not straightforward. “The bond gives the ability to fund mature operations offshore, and also repays some offshore loans and short term debt. Beyond that, there are potential acquisitions as well. It’s a mixed bag.”

But why now? “With $2 billion available [its net cash position is $2.4 billion], this is not a company that needed the money,” agreed one banker close to the deal. But, since the completion of a global roadshow several weeks ago, the company had been watching the markets closely. “In Europe you see windows open and close with maybe one day a week that’s superb for issuance, and the rest pretty negative. They were looking towards next year and saying: what’s the chance that January is going to be any better? There are a lot of big redemption spikes coming for sovereigns in Europe.

“Could they have waited six months and had another window? Potentially, but a trade was on the table at a price that was OK for them, and they managed to achieve $600 million. For a debut borrower, that’s a big-size transaction.”

The deal certainly stood out from the other deals that have thrived in difficult markets in recent weeks, chiefly top-drawer Koreans and other big names such as ICBC or the Indonesian sovereign, all of which have long track records in the dollar markets and loyal followers in the investment community. “This is an interesting time of year to be bringing a new sector and debut borrower,” said one banker. “For China overall, it was incredibly front-loaded in the first half of the year. Then you had the problems in May around Sino-Forest, and so on. China had an interesting ride this year, with corporate governance being the focal point; fair play to management in overcoming that difficulty and being the first Chinese corporate to issue [in dollars] since May.” And the internet sector is not even well-trodden by European issuers, let alone Chinese. “It was an entirely new sector for emerging market investors as well, who obviously haven’t bought the likes of Google and Microsoft.”

In the circumstances, although the $750 million-$1 billion levels mooted during the roadshow were not achieved, joint global coordinators Goldman Sachs and Deutsche Bank (with joint bookrunners Credit Suisse and HSBC) did well to get the deal away at all; pricing, with no obvious comparables, took in mind a range of reference points from US internet players to Chinese SOEs and major shareholder Naspers (a South African company with 35% of the company). The deal eventually sold 45% to the US, 45% to Asia and 10% to Europe. “This is an emerging market buyer base: you’re looking at the big macro EM funds,” said one banker.

But once out of the blocks, things quickly turned south. After pricing at 375 basis points it went as wide as 392 basis points after pricing, and yesterday [Thursday] was being bid at around 388. Partly, this is mitigated by deteriorating conditions as the deal was being concluded. “We priced this at 4.30 in the morning on Tuesday Asia time; S&P had come out with a negative outlook on the 15 European sovereigns at 2.30, so at the back end of the process there was negative sentiment in the market,” says one banker close to the deal. “The follow-through after that wasn’t too bad, but the initial reaction was pretty negative.” That said, the bonds widened further than the broader market after launch, before improving yesterday morning. “It’s slightly wide of re-offer, but at this time of year when liquidity is pretty think, that amplifies problems,” said one banker. “This is a different type of credit, and banks have significantly downsized credit trading in Asia.”

The transaction was also interesting for highlighting variable interest entities, or VIEs – fairly commonplace in Chinese deals but increasingly in the spotlight given the governance issues at many Chinese companies this year. In offshore listed companies like Tencent, which is listed in Hong Kong, VIEs hold the licences necessary to conduct business. There is some concern about what happens if there are regulatory changes in this area, and in particular if foreign owners could find their assets (notably intellectual property assets or licences) moving from one structure into another without their control. To mitigate this concern, Tencent included a change of control clause for any change of law around VIEs.

These issues have become increasingly important in China this year. “For any deal, ultimately the closer you are to the asset and the more transparent the ownership structure, the better,” said Bryan Collins, portfolio manager for fixed income at Fidelity. “If you do not get that level of comfort, then you need to be sure you are getting adequately compensated, and if not then you should question whether to participate.”

Others had different concerns. “I didn’t participate in Tencent,” said one investor. “The risk of this bond was not in the issuer’s business fundamentals, which are in fact quite strong, but with the likelihood of a follow-on acquisition and the potential for more debt issuance. That is what turned us away because at this time it is not possible to gauge the size of these material risks.”

The bond had a coupon of 4.625%, reoffered at 99.74 to yield 4.684%. The change of control clause involves a put at 101 if any party, Naspers aside, builds a stake of more than 35% of the company.

HANA

The appetite for top Korean financials was illustrated once again on Thursday morning, Asia time, as Hana Bank’s books were almost nine times covered on a $500 million, 5.5-year trade.

The Reg S/Rule 144a senior notes tightened heavily from guidance of 370 basis points over five-year treasuries to price at 345bp. The notes carried a coupon of 4.25% and priced at 99.458 to yield 4.362%. Like many recent deals, this one was completed quickly. “This was perceived to be a one-day execution, with almost no rolling off into the next day; that’s consistent with almost everything we’ve seen this year,” said one person close to the deal. “The issuer had a preference to do something this side of Christmas, and possibly to take advantage of a let-up in supply.” It also benefited from reasonably benign sentiment towards Europe, and also from a Standard & Poor’s upgrade for Hana Bank on the morning of the deal.

Initial guidance was, one banker said, “a fairly generous starting point,” which after allowing for about 15 basis points to cover the difference between a 5-year benchmark and a 5.5 year deal, equated to a new issue concession of about 40 basis points. Final pricing was more like a 15 basis point concession. “Starting as we did [with generous terms, then tightening guidance] is in line with how you’re seeing deals getting done,” said one banker. “Hyundai Motors last week had to do a similar thing to get books up to a decent size.”

The books in the end were more than decent. Like Hyundai Motors, this was capped at US$500 million; aided by the scarcity value, the books eventually closed at $4.4 billion from 259 accounts, although not all of that book represented investors who stayed in at lower pricing. By region, 67% went to Asia, 18% the US and 15% Europe; by investor type, 62% went to funds, 14% banks, insurance 9%, central banks and public institutions 7%, private banks 4%, and others 4%.

Barclays Capital, Bank of America Merrill Lynch, Citi and HSBC were joint bookrunners on the deal. In aftermarket pricing yesterday it was being quoted at 344 bp, marginally inside its launch price.

FUTURE

So, is that it for the year? Issuers and investors do not expect many more significant trades before Christmas, although some may squeeze through.

Of well-flagged deals, the only outstanding one from Asia is an expected deal from Reliance Industries, covered in previous editions of Euroweek. The Indian issuer has appointed Bank of America Merrill Lynch, Citigroup and UBS on a deal widely expected to be a 10-year bond raising around US$1 billion, but those close to it were coy about its likely timing yesterday.

And time is running out for anything to be launched quickly. “Hana was definitely one of the last on our calendar,” said one banker. “There are always things on the backlog, but the reality of getting something priced next week becomes more difficult.” Anything that does price next week will have a settlement date in the week of the 19^th, when many people are leaving the office and shutting down books.

Investors are not expecting much more issuance. “I expect the primary markets to be generally quiet as we move further into December,” said Scott Bennett, head of Asian credit at Aberdeen Asset Management. “There will likely be another few deals from existing issuers that offer a good new issue concession, but I wouldn’t expect an inaugural issuer.”

Another investor added: “Any new issues between now and the end of the year are likely to be opportunistic in nature.”

That said, a piece of good news from Europe would open a window for a fleet-footed borrower. Friday’s EU Summit will again be crucial for market sentiment. “Tonight will be the start of what promises to be a volatile yet fascinating journey for the single currency,” said Stan Shamu at IG Markets [speaking yesterday, ahead of the ECB’s rates decision]. “There are many highlighting that the next few days are pivotal, not just for the fortunes of sovereigns, but the entire banking system.”

Elsewhere, there is a sense that there is still room for one or two more dim sum borrowers to access the market before the year-end, even though the supply-demand dynamics have shifted markedly in that market during the course of the year. Dim sum issues have frequently managed to get away despite bad news from the eurozone.