Euroweek equity capital markets round-up, September 17

Euroweek Equity capital markets roundup – September 17 2010

Convertibles are back

Three convertibles in Asia in the space of a week underline a swift revival in a market that had been moribund for months.

According to Dealogic, the three new deals bring the year-to-date number of Asia ex-Japan convertibles to 99, compared to 171 in 2009. The total volume (US$18.511 billion) is higher than 2009’s US$13.43 billion, but that is thanks largely to two deals from Bank of China and ICBC which accounted for almost US$10 billion between them.

The first of the new crop came from Chinese property developer Shui On Land, which raised RMB2.7 billion (US$400 million) in a five-year put three deal denominated in renminbi but settled in US dollars. The Standard Chartered-led deal, completed on Friday September 10, was upsized from an initial RMB2.04 billion (US$300 million).

One interesting characteristic of the Shui On deal was the use of a synthetic stock borrow facility, using a HK$1 billion equity swap between Standard Chartered and another company related to Shui On. This created a short position that investors in the convertible could then use to hedge their equity position.

While equity swaps have been done before, notably by Country Garden in 2008, this one was remarkable because the company on the end of the swap was not the issuer. Instead, Shui On’s chairman, Vincent HS Lo, created a holding company to conduct the swap.

The reason for this odd-looking approach has to do with accounting. When the swap is done at the public listed company level, the accounting for it is done as an equity derivative, which means that the value of the swap changes based on how the share price moves. If the share price rises, there is additional income reported through the P&L; if it declines, as it did for companies like Country Garden in the financial crisis, it goes the other way. “From a pure cash perspective, it doesn’t make a difference: there isn’t money flowing in and out the door,” says a banker. “But from an accounting perspective, it’s not great.”

Doing it through a separate company like this removes that accounting volatility. “From the issuer and investor point of view, it’s just a plain vanilla convertible,” says someone close to the deal. “But for the company there will be no swings from the accounting level.” As for the chairman, he is effectively, synthetically, buying the company’s stock, and hence taking a positive view on its long-term prospects. “It’s exactly the same as being an ordinary shareholder, except it’s conducted synthetically.”

The deal came with a mighty premium of 36.4%, the highest in Asia since March 2008, with a conversion price of HK$4.87 compared to the close before pricing of HK$3.57. The coupon was marketed in a 3.5% to 4.5% range, fixing at 4.5%. The three-year put allows investors to put the bonds back to the issuer subject to a 130% hurdle.

One consequence of the stock borrow was that hedge funds made up the bulk of the deal – about 66%, with 20% going to proprietary trading desks and 14% to outright investors and private banks. Geographically, 81% of the deal went to Asia and the remainder to Europe. Those close to the deal say it was fully covered within three hours. Notably, it has also traded up, and at the time of writing was at 104.

Next came LG Uplus, the Korean telecommunications company, which raised US$300 million in a convertible the following Monday.

The distinction of this deal was that the bonds convert into treasury shares, which were created through a merger between LG Telecom and two other LG companies in January. Treasury shares, amounting to 16% of outstanding share capital for the merged group, behave like other shares from an investor perspective but are an irksome intrusion on the books of the company.

Since the company wants to get those shares off its books and hence wants the bonds to convert, they have been structured in such a way as to encourage conversion. It is just a two year deal, with an 18-month put, unlike the five-year put three structures that have been more common in Asia lately; it pays its coupons early, at six months and 12 months instead of 12 and 24; and it offers compensation for all first year dividends but only for yields over 3% in the second year. All of these ought to prompt early conversion.

While it didn’t quite reach the Shui On premium, it did offer 25%, which is very high for a convertible that cannot be hedged (unlike Shui On, it did not offer an equity swap facility, although bookrunner Morgan Stanley is believed to have been providing a hedge). Another distinction was that it is the first convertible to be denominated in won, but settled in US dollars, which gave investors a currency play too if the won continues to appreciate as many expect. The deal was three times covered, and correspondingly priced its coupon near the low end of a 2.25%-3.75% marketing range at 2.5%.

This trend of launching in one currency and settling in another is, again, about accounting. It’s most common for Chinese companies based in Hong Kong. “From an accounting standpoint most companies keep their books in RMB as their functional currency, but if they issue equity-linked securities they denominate them in a different currency so they don’t have to mark to market the entire transaction,” or specifically the equity option within it, a banker explains. The same principle applies to the LG Uplus deal.

Finally, on Tuesday, Maoye International, a Chinese department store operator listed in Hong Kong, raised HK$1.17 billion (US$150 million) from a five year, three-year put convertible. The JP Morgan-led deal started out looking for HK$971 million (US$125 million), then used part of an upsize option. The full option, which would have brought the deal size to US$200 million, was not used.

The deal was offered at a conversion premium of 23.2% to 33.4% above a reference share price of HK$3.42. Oddly, this reference price was different to the previous close of HK$3.51. Euroweek understands that Moaye’s chairman had required a minimum 23.2% premium, but that for investors, the final price (at the bottom of the range) equated to a 20% premium to the close.

 Despite coming at the bottom of the premium range, the deal’s coupon, offered at 2-3%, was fixed at the top. Like LG Uplus, it was done without the availability of an equity swap to hedge; for this reason two thirds of the deal went to outright investors and just one third to hedge funds, unlike Shui On which went mainly to hedge funds.

“It demonstrates that in certain sectors that people have a lot of faith in – like Chinese consumer goods – there is still scope to get no-borrow transactions done fairly easily,” says someone close to the deal. “There is a lot of demand out there.” It was sold roughly 50-50 to Europe and Asia, to about 50 investors.

Why the revival in convertibles? In fact, Asia started the year quite well for convertible issuance, but problems in Greece and elsewhere in Europe punctured the market by removing the key European hedge fund demand. “What has opened things up again is Greece getting resolved and the equity markets rebounding,” says one banker. “That has helped get more outright interest in convertibles, with more investors we can sell to and hence more deals. There are three or four months worth of cash sitting on the sideline.”

Bankers report full pipelines and some feel conditions may be perfect for several weeks of issuance. “Some very large IPOs are going to hit the ground in the first week of October, and at that time investors may start focusing on them a bit more,” says another banker. “So issuers wanting to do a convertible may feel it makes sense to do so before then.”

Follow-ons and blocks continues

It has been another busy week for follow-on offerings in Asia, including the customary chunk of accelerated block trades.

The biggest of the week was a HK$3.82 billion (US$493 million) follow-on for China National Building Materials in a deal led by Morgan Stanley and CICC. The deal was made up of 238.9 million H shares, including 20.6 million shares which were sold by major shareholder the National Social Security Fund; in total they amounted to 19.9% of CNBM’s H-share capital.

The deal was priced at HK$16 after marketing in a HK$15.85-HK$16.65 range; the final price was a 6.5% discount to the previous closing price of HK$17.12. While that discount is deeper than in recent follow-on deals of stock in heavyweights like China Mobile and Ping An, the share price was already at a high for 2010 and has rallied by more than 60% in the last four months. It is understood to have been three times covered, distributed chiefly in Asia to a range of long-only funds, sovereign wealth funds and hedge funds.

Two other Chinese companies got major placements away. In one, China Resources Gas raised HK$2.47 billion (US$317 million) shortly after announcing a HK$2 billion asset injection from its parent company to fund the acquisition of several city gas distribution businesses. This deal priced at the bottom of a HK$10.75 to HK$10.95 range, amounting to a 5.2% discount, and did not use a 22% upsize option; it was considered a tough sell coming so soon after the asset injection announcement. An issue of new shares to the parent company, to cover the asset injection, will be the same as the price from this placement. Credit Suisse led the deal.

In the other, China High Speed Transmission raised HK$3.25 billion (US$418 million) on the evening of September 9 in a block trade managed by Goldman Sachs, which had also been on the US$6.5 billion sale of Vodafone’s China Mobile stake earlier in the week. China High Speed set out with a range of a 4.6% to 10% discount – much wider than China Mobile’s 3.4% or Ping An’s 1.2% – and settled at 6%. With those terms, the deal was three times covered and had apparently been covered once within half an hour of the books opening. The deal involved 130 million shares sold by the company as a top-up placement, and 57 million sold by Fortune Apex, which holds stock owned by the company’s management.

China High Speed represented one of two successes around Chinese wind power in the course of the week; the company produces gearboxes for wind power turbines. Another company, China Ming Yang Wind Power, this week covered its US$400 million New York Stock Exchange IPO on the first day of bookbuilding. This deal was detailed in last week’s column.

Elsewhere, in Singapore Ascott REIT announced it had raised S$233.8 million from institutional investors ahead of a preferential rights issue due to take place later this month. Ascott is part of the CapitaLand family, and CapitaLand separately announced it would take up its pro rata share of both placement and preferential offering. It is raising funds for an acquisition of 28 new serviced residence properties, mainly in Europe. Credit Suisse and DBS led this deal, which priced at S$1.08, near the bottom of a S$1.07-1.13 range, a discount of 6.1% to the previous close.

And in Thailand, Thai Airways has priced its long-awaited follow-on equity offering, which will raise Bt15 billion (US$486 million) in Thailand’s biggest equity raising this year. The final price is Bt31 per share, a 14.5% discount to the previous close, in a deal that was constructed without a guidance range. Morgan Stanley is joint global coordinator and sole international bookrunner, with Finansa and Phatra joint global coordinators and domestic bookrunners.

Finally, as jumbo IPOs like Coal India, Indofood CBP and Petronas Chemicals near the finish line, other smaller deals are still launching. This week Boshiwa, a retailer of children’s clothes, began bookbuilding for an IPO that could raise up to US$368 million post-greenshoe. Led by Credit Suisse, UBS, BoCom International and Deutsche, the deal will close books and price on September 21 with listing on September 29. The Government of Singapore Investment Corporation, Mirae Asset Management and Marin Currie have all agreed to subscribe and will take up to 30% of the deal.