Euroweek high yield report: Issuer roundtable

Euroweek High Yield Report, July 2011

Participants and their deals

Muktesh Mukherjee, General Manager, China Oriental, and chief representative of shareholder Arcelor Mittal. Launched a US$550 million bond in August 2010, paying 8%.

Thomas Husted, Finance Director, Delta Dunia. Delta Dunia is the listed holding company of PT Bukit Mamkur Mandiri Utama, or BUMA. The acquisition of BUMA in 2009 involved raising $600 million of debt financing, $315 million of it in an issue of senior secured five-year notes; subsequently refinanced through loan markets.

Estella Ng, CFO, Country Garden. Regular high yield issuer; raised US$900 million in a seven year non-call four global bond in February, with an 11.25% yield.

Parry Tse, CFO, Evergrande. Raised US$750 million in global bond in 2010, then raised RMB9.25 billion in a synthetic RMB bond issue, the biggest in the market to date.

Atsushi Tanaka, head of corporate planning, eAccess. Completed a US$420 million seven-year dollar bond, priced at 8.25%, and a Eu200 million seven year bond, at 8.375%, in March. A rare high yield issue from Japan, it closed immediately after the earthquake and tsunami.

Euroweek: From your perspective as an issuer, how have Asia’s high yield markets developed as a source of funding?

Muktesh Mukherjee, Arcelor Mittal/China Oriental: High yield used to be basically a funding source for real estate companies out of China, and that pretty much remained the case until China Oriental came to the market last year. It opened up a whole new category for non-property issuers. There are a lot of companies, especially Hong Kong-listed Chinese companies, for whom it’s easier to remit the funds back, who are looking at the markets now. I think the markets have developed significantly since our issue, demonstrated by the number of issuers who have come to market since our deal in August last year. But once you have a lot of volume, quality becomes an issue; I’m not so sure all high yield issuers have the same quality. That said, there is a lot of choice out there, and investors can be more picky.

Thomas Husted, Delta Dunia: In 2009 while I was working at Northstar, a leading Indonesian focused private equity fund, we accessed the high yield market to provide financing for our acquisition of BUMA, Indonesia’s second largest coal mine contracting company.  The acquisition required $600 million in debt financing, which was well beyond the support provided by banks at the time.  We ultimately paired a four year $285 million syndicated loan with a $315 million five year bond to reach the targeted financing.  To our knowledge this is the only acquisition financing in Asia since the 2008 financial crisis that has accessed the high yield market.  Despite the rarity of high yield being used for acquisitions, it is a viable and useful option for sponsors.

Estella Ng, Country Garden: In my view, the Asian high yield market has become well established as a source of funding – especially recently where there have been a number of cases where PRC issuers have come to the market. I think it’s very successful.

Parry Tse, Evergrande: High yield is a very important source of funding for Chinese enterprises, especially the property sector. For developers, there are three forms of funding: onshore construction loans, sales proceeds and offshore fundings. Onshore loans and sales proceeds have quite a lot of restrictions on their use: for example, the sale proceeds have to be put into an escrow account, theoretically until the construction is complete and the property is handed over to the buyer. Only then can they withdraw the funds for other purposes such as the purchase of land and other working capital. Onshore construction loans can’t be used for other projects, just to pay down outstanding construction costs. So the use of funds is very limited, which is why high yield is a very important source of funding for development. When a company wants to expand, they must look offshore: high yield bonds, RMB bonds or an IPO.

For other industries too, high yield funding is very important this year, because inflation in the PRC is a very important problem. The PRC government is trying a number of measures, such as increased interest rates and cost of funding, as well as restrictions on liquidity. On that basis, companies other than property developers may also need to look for offshore funding.

Atsushi Tanaka, eAccess: This was the first time in over 20 years for a Japanese company to issue a high yield bond outside Japan. It was sold mainly in the US but we did the marketing and roadshow in Asia and Europe as well. The high yield market does not really exist here in Japan, so we thought this would be a way to access a new source of funding. We gave it a try.

Euroweek: What has been your experience in your recent issues?

Mukherjee: Because we were the first non-state-owned, non-property issue out there, there were a lot of questions. There is, in general, some skepticism about China, related to political and legal risk; you can’t collect in the case of a default, so there is a premium on any China issue. It was challenging to get your foot in the door: there were no benchmarks from the past for what kind of coupon could be achieved. It was not the easiest of exercises.

But with the sector being steel, it’s a basic commodity which is a driving force of any industry. And what helped China Oriental was its relationship with Arcelor Mittal. Because Arcelor Mittal is well known, it did make it easier for them to come to market, and the credibility helped a great deal.

The other issue last year was the volatility of the market, especially because of Greece in May, when we were on our roadshow for the first issue. There were some challenges involved in convincing investors that this was something they should seriously consider and do homework on, and managing the volatility of the markets was difficult, but we lived up to those challenges.

The markets have matured since. They have gone back to being choppy in the last month or so, but I am satisfied as our bonds have outperformed the market.

Tse: In January last year we issued a traditional US dollar bond, and earlier this year a synthetic RMB bond. In terms of procedure, they were very different. When we issued the dollar bond, because the majority of our investor profile is in the US, we needed to do quite a lot of preparation work to fulfill the Regulation 144a requirements. It took three or four weeks of preparation. When we issued a synthetic RMB bond, the majority of investors were located in Hong Kong and Singapore. Investors in this region have a better expectation of appreciation of the RMB, so were very interested to purchase RMB bonds. Because we did not need to go to the US for marketing, it only took two weeks of preparation work. It saves a lot of time.

Husted: Our most recent interaction with the bond market was a successful tender offer and consent solicitation that we launched in the fourth quarter of 2010.  The tender offer was a result of withholding tax changes instituted by the Indonesian government in January 2010, which triggered a tax call provision in our bond documentation.  The tax changes were material for BUMA and increased the effective cost of our bond (coupon plus a 20% tax gross up) to 14.7%.  The tax call allowed us to redeem the bond at par. However, we decided to offer 106, or a small premium the market offer at the time.  This was a strategic decision designed to engender goodwill from bondholders and ensure that BUMA would have ready access to the market in the future.  Ultimately, 97% of bondholders subscribed to the tender offer and we successfully refinanced the bond with a bank loan priced at libor + 475bps.  This was a win-win result for all parties involved.

Ng: The most recent one we did was in February. It was good timing: a very good time to do something. We starting talking to investors and came up with one of the largest issues in the market, the largest from a non-investment grade issuer. When you look at the investor response, it was oversubscribed more than four times. There was strong appetite from institutions internationally – not just from Asia, which provided 50%, but 30% from the United States. More importantly, most of the investors had supported our previous issues; we thank them for their trust and help. As a repeat issuer, we always try to put the interests of bondholders first, and to ensure that existing bondholders’ interests will be protected.

The offshore RMB is a good market, and something that will provide an alternative for issuers. But for us, we are already established in the dollar high yield market, where there is an established curve. The tenor for RMB bonds is not as long – five years at the most – and when you can get onshore construction loans with a tenor of two to three years already, it’s not long enough. We can tap longer term tenor from dollars, and in the US market we think the liquidity is better.

Tanaka: I wouldn’t say it was easy. We launched the bond towards the end of March, then went out on the roadshow. As we were visiting US investors – we had only just arrived in the US – the earthquake and tsunami hit. It was quite tough: the stock market collapsed and I’m sure that some of the other bond issuers needed to think about the timing of the launch and the pricing of the deal. If we were a US issuer, it might have been a bit easier, but we had operations in Japan. There were a lot of questions about the impact of the earthquake and tsunami and the nuclear issue. We were initially targeting the pricing towards the end of March, but we extended a little bit, because investors wanted to be more comfortable with the situation in Japan. We decided to complete the roadshow in Asia, the US and Europe, and basically do the best we can, and see how Japan and the US market evolve after the incident. I think UBS, who led this transaction on our behalf, did a good job and we started getting positive feedback from high yield investors. We got good names, big names, and then huge demand followed, beyond our expectations. We are a profitable company, we generate free cashflow, and we are growing. So I think investors, regardless of the incident in Japan, valued us in terms of cashflow generation. We completed everything on April 1.

How would you describe the investor base for Asian high yield issuers – both geographically and in terms of investor type?

Husted: Almost 50% of our bond was distributed to accounts based in the USA.  This is a disproportionally high percentage for an Indonesian issuer and reflects a greater level of comfort for leveraged buyout deals in that market.  Despite the structured nature of the acquisition, investors there tended to look at the key fundamentals of the business and the moderate leverage (approximately three times debt to EBITDA) and decided to participate.

Ng: Our experience is that there is increasing interest from private banks, and increasing demand. Also, when we did our around the world roadshow, we found that there is more interest from the US, given market conditions recently. They are looking for good, steady names. Europe is quite steady; it’s about 20% each time.

Mukherjee: It depends very much on the industry. If it’s IT-related, it’s more US investors who have a better understanding of that sector. If it’s real estate, you see much more Asian investors who have more appetite for risk and a better understanding of the market. A company like ours was split between Asian and western investors, more of a 50-50 mix. It’s very much dependent on the understanding of the industry.

There is a little less appetite for risk in the US and Europe than in Asia, so if it is an issue where the company is unheard of or doesn’t have the profile or backing of someone who is known internationally, then it will be more Asian investors who are interested. My understanding is that hedge funds are very active, as is private wealth management, so much more money is coming here. Banks are part of it, but institutional investors, mutual funds and hedge funds are probably the most active.

Tse: I think market appetite has been very strong for RMB bonds this year. But it may be a temporary situation: you would expect the appreciation of the RMB to be vigorous in the next couple of years, but it will just be a transitional period. When the expectation of RMB appreciation is no longer so high, investors may not have the same interest in RMB bonds. The traditional US dollar bond market is still very important and will continue to be the main source of financing in future.

Tanaka: We pretty much attracted all the investors: well-known high yield houses, big long-only investors. My colleague went on the Asia roadshow and tried to get one on one meetings; there ended up being about 105 of them. There was huge interest in issuance. In terms of allocation, we allocated fairly on in the end to US, European and Asian investors.

Has the availability of bank lending – or a tightening of that availability – increased the appeal of high yield bond markets? How does high yield fit with other available funding sources for you?

Husted: At this time, banks are our preferred financing alternative as we can achieve bond-like repayment profiles at competitive pricing levels with tax efficiency and no offshore SPV structuring.  We recently closed an $800 million bank loan to refinance our existing bank debt and put in place some committed capex lines.  We will continue to have financing requirements in the near term for heavy mining equipment as we expand BUMA’s contracting business.  Primary options for financing this growth will be banks, export credit agencies and vendor financing.  Despite these preferences, we are maintaining our credit ratings and will closely monitor developments in the high yield market, the Indonesian regulatory regime and tax rules.

Mukherjee: I think availability of capital – or the lack of availability of capital – has been overblown. It’s not a question of lack of availability as much as it is the rising interest rates and exchange rates. People are playing two games: taking advantage of borrowing in dollars, with most of their assets being in RMB, which is appreciated in the last 12 months and will continue to appreciate as there is more pressure on China to do something about their currency; and interest rates, because at this point the coupons will make sense if interest rates keep going up. My view is that I don’t think Chinese authorities are interested in jacking up rates much more than they are today to fight inflation; they would rather use tools like the reserve ratios of banks and capital requirements to keep a lid on liquidity. If you’re a good company I don’t think there’s any issue about obtaining funds in China. Rather, it is an interest rate and an exchange rate game.

Ng: For us, the banking channel charges a higher lending rate, 5 or 10% premium above the PBOC rate. For small players, it’s even worse: 10 to 20% premium over the PBOC rate. And lenders are asking for more collateral. So we expect more and more PRC companies to approach the high yield markets for funding.

Tse: If you do business in China, it’s always subject to policy. And policy in China is always up and down. It is important to have a stable source of funding, and on that basis I would say high yield bonds provide the most stable source. Another factor to consider is interest rates. In the PRC the benchmark rate has increased and is now 6.5%. If you compare that interest rate with high yield bonds it is more or less the same; in fact, some people expect the interest rate for onshore funding will be higher than high yield bonds by later this year. On that basis, high yield bonds will become an even more important source of funding for Chinese corporations.

Tanaka: We actually did this dual tranche. It was a refinancing of our mobile arm, a company called eMobile which merged with eAccess, so it was refinancing a bank borrowing we did in 2006. So we raised money from the banks as well as high yield: it was a combination of both.

What advice would you have for other issuers on structuring and covenant packages in high yield bonds?

Husted:  In the BUMA bond, we agreed to a set of very restrictive covenants by high yield standards early in the process.  As the financing developed we added a loan syndication to the overall package and it became clear that bond investors took more comfort from the participation of banks than from the restrictive bond covenants.  There was effectively a symbiotic relationship between the two creditor groups as both took comfort from the participation of the other.  The banks were pleased that the bondholders were willing to lend over half of the required debt as a bullet that matured after the loan.  Likewise the bondholders took great comfort from the fact that the banks would be actively monitoring the company and imposing a set of maintenance covenants.   So, for issuers that will maintain bank lines after the issuance of a bond, I would encourage them to describe the bank covenants to their potential bondholders.  This should also have a positive effect on pricing as it demonstrates discipline and the ability to access to multiple debt markets.

Mukherjee: Usually the companies related to these high yield issues are companies based in the Caymans or British Virgin Islands, so some kind of transparency on the holding company structure is key. The change of control clause is very key to how investors perceive an issue, because a lot of these companies seem to have a dominant single shareholder. What happens if that major shareholder leaves? Interest coverage ratios, restricted payments baskets so you don’t use the money outside your core business… there’s a lot of transparency required. But we didn’t feel the covenant ratios we had to abide by were any different from any other issuer in any other market. It’s just a question of being in line and transparently and efficiently communicating. I remember investors asking about debt covenants. Although we reassured investors that our ability to keep debt to EBITDA below 2.5 times had not changed, there was some concern because there was not a debt to EBITDA covenant. But investors got used to it: debt interest coverage is more important.

Tse: In terms of structure, there is no problem for the majority of companies. The main structure is the listed company sets up a Cayman Island or BVI company and lists in Hong Kong. That structure is very suitable for high yield bonds; you don’t need any approval from the PRC government. Some listed companies in Hong Kong have a lot of restrictions: they need to go through administrative procedures and get approval from the PRC government, which makes it difficult for them to raise offshore bonds.

In terms of financial covenants, the key one is the FCCR [fixed charge coverage ratio]. But I noticed early this year that companies were issuing with freer terms: the FCCR for some issuers has been reduced from 3.5 to 3, although that may be related to the financial position of the issuer. I think that is a big achievement and has reduced the requirements for high yield bond issuers. Moving forward I expect covenants will not be as tight as in previous years.

Ng: Ensure that your financials are updated so you can monitor your internal financial ratio, so you can ensure you are meeting minimum requirements.

Tanaka: Our structure was quite unique, because we did both a bank loan and a high yield bond. It’s a little complex. But obviously it opened up a lot of eyes to Japanese companies who may be interested in trying to raise money not only inside Japan but outside. I don’t think a lot of companies look at this opportunity, because it is outside Japan.

Where do you think the Asian high yield bond market is heading?

Ng: It is still a good source of funding for PRC companies, and after four months of very active borrowing this year, it will remain good for the next six months. Now maybe it is time for the convertible bond market to return.

Mukherjee: It’s much more developed than it once was, and I see it becoming more important in terms of financing. Whether it’s dollar issuers, an RMB issuer payable in dollars, or just a pure RMB issue, these things take some time to play out. I’m not a big believer in the appreciation of the RMB forever, and the US dollar remains the true world currency, so in my mind that market is here to stay. Since there is so much more interest and awareness, it will be easier for new issuers going forward, as well as existing issuers who would like to do another deal in future.

Tse: The bond market is still very strong. In the past few months quite a few corporations have successfully issued high yield bonds with a very high rate of oversubscription. But I think this may not be the situation for all industries. The demand for PRC property developers will not be that good in the next couple of months because of a few surprises in the market in the last few months; I heard some Chinese property developers tried to launch, sounded out the market, but found the appetite was not so good so postponed the deal. Moving forward, I would say the dollar bond market will still be very strong, but in the second half of the year not too many property developers will tap the market successfully.

Tanata: We wish we had a similar type of market here in Japan, but that market doesn’t exist. We issued dollar and euro denominated bonds, and swapped everything, 100%, into yen. If the market existed here in Japan, we wouldn’t have to do that. We wish this type of market would evolve in Japan.