Lotte Shopping brings Asia’s first equity-linked deal this year

Asia’s equity-linked market was given a boost yesterday when two new issues hit the market within hours of each other. The deals raised a combined $806 million and added to the hopes that 2013 will be a better year for new issuance than 2012, which, according to Dealogic, saw a mere $7.3 billion of new paper in Asia outside China’s A-share market.

First out was Korean department store operator Lotte Shopping, which launched a relatively well-flagged bond that is exchangeable into Lotte Himart, the retailer of consumer electronics that it bought a majority stake in last year. The deal was denominated in Korean won, although settled in US dollars, and ended up raising W321.2 billion ($303 million).

Two hours later it was joined by a convertible bond from Shanghai Industrial, a Chinese conglomerate that gets half of its revenues from the real estate sector. That deal was denominated in Hong Kong dollars and raised HK$3.9 billion ($503 million). (For more on this deal, see separate story on our website.)

CB investors actually got their first chance to increase their exposure to Asia already on Tuesday night when Singapore-listed Yangzijiang Shipbuilding sold 330 million warrants that could end up raising Rmb2.51 billion ($400 million) if fully exercised and converted into new shares. While technically not a convertible bond, the warrants are very similar to buying a fully asset-swapped CB and indeed, the deal was marketed and sold exclusively to hedge funds and other technical investors who normally invest in CBs, a banker said.

The warrants are not attached to a loan and hence don’t really result in much upfront proceeds. However, they may allow the company to raise equity financing at a good price in the future. The deal was arranged by Citi.

Aside from being denominated in won, the Lotte Shopping transaction had a common structure with a five-year maturity and a three-year put. It is also callable after three years, subject to a 130% hurdle.

The exchangeable bond (EB) was pretty aggressively priced with a zero percent coupon and zero percent yield, which were both fixed at launch. The exchange premium was marketed in a range between 27.5% and 32.5% over yesterday’s close of W71,200 and eventually fixed at the low end. That resulted in an exchange price of W90,780 per share, which is slightly above analysts’ average 12-month target price of W90.714, according to Bloomberg data.

One source suggested that the deal might have done somewhat better if Shanghai Industrial hadn’t launched a second deal so soon afterwards. However, the fact that it was denominated in won and the combination of no coupon and no yield also reduced the interest from outright investors.

One sign that there was some uncertainty in the market about the structure, the pricing and the overall appetite for the transaction was that the EB was offered slightly below par in the grey market during the two-and-a-half-hour bookbuilding.

On the other hand, investors are eager for new equity-linked issuance out of Asia and this was the first deal of the year. For that reason alone it attracted a lot of interest, even though all of that may not have turned into actual orders. Lotte Shopping is also viewed as a high-quality credit. The company has one other outstanding CB, a $900 million dual-currency deal that was denominated in dollars and Japanese yen. That deal was named by FinanceAsia as the best equity-linked deal in Asia ex-Japan in 2011.

This is only the second equity-linked deal out of Korea to be denominated in won and settled in US dollars after a won-linked CB by telecom firm LG U-Plus in 2010 and aside from the unfamiliarity that investors may have with the structure, it may also require some additional currency hedging compared to a straight dollar (or won) deal.

To ensure that the demand from hedge fund investors would be strong enough to make up for the lesser interest by outrights, the deal included a stock borrow facility with enough shares to cover 50% of the deal. The shares were provided by Lotte Shopping.

In the end, sources said not all of available stock borrow was taken up. In fact, one source estimated that about 70% of the demand came from outright investors in the end. In all, slightly more than 40 investors participated in the transaction, which was said to have been well covered.

This helped lift the price in the grey market and late in the Hong Kong evening the EB was offered at par and bid slightly below at 99.5, CB specialists said.

The EB was marketed at a credit spread of 150bp, while the stock borrow cost was assumed at 1.5%. There is a dividend protection for investors for all cash dividends above W750 per share per year.

Based on a 27.5% exchange premium the bond floor ended up at 90.5% and the implied volatility at about 28.5%. The latter increases to about 31% if you include 4% stock slippage and compares to a long-term historic volatility of around 35%.

One slightly unusual feature with this deal was that the EB was to be exchangeable into a fixed number of shares (3.45 million) and as a result the exact deal size wasn’t determined until after the final terms were fixed. At launch the indication was that the deal could range from the equivalent of $303 million to $315 million.

The reason for this was that Lotte Shopping wants to retain absolute control of Lotte Himart and therefore couldn’t sell more than a 15% stake. If fully exchanged into shares, the EB will reduce Lotte Shopping’s holdings to just over 50% from 65% at present.

The deal was arranged by Bank of America Merrill Lynch, Citi, Goldman Sachs, HSBC, Nomura and UBS.