Chinese electric car manufacturer Nio completed its first fundraising exercise since its US initial public offering in September, by raising $650 million from a convertible bond sale on Thursday.
The credit cost of the deal was higher than expected, as the company and its bankers navigated a host of challenges, but share investors largely welcomed the news.
New York-listed Nio, dubbed the 'Tesla of China' by both advocates and journalists seeking a handy reference point, returned cap in hand to capital markets to plug a funding shortfall in its expansion plans.
The company has said that it needs to invest $1.8 billion over the next three years to scale up production and build out its sales network and its IPO just four months earlier had initially targeted that amount. But in the end it only raised $1 billion.
The company had $1.1 billion in cash holdings as of the end of 2017, according to its IPO prospectus.
From a purely equity standpoint, Nio appeared to benefit from the four-month gap since it priced the convertible note off its Wednesday close of $7.46. So it raised new cash at a valuation premium of 19% over its September IPO price of $6.25.
To be sure, the unrated issuer had to overcome a number of challenges to get the trade across the finish line, most notably its short stock-market history and the lack of a credit benchmark for the new deal. And that helped to push up the final yield offered to investors.
With only four months of data to play with, there was little reference to the long-run volatility of Nio's shares, which is a key input when calculating fair value and determining the attractiveness of a convertible bond, especially for hedge funds. The challenge was made all the greater by the high volatility that was seen in the first week of trading when Nio's shares spiked to as high as $11.6 before falling back to around $7.
Generally speaking, convertible bond investors look at stock volatility over a period of three to 12 months.
And with a young, high-risk sector like the electric car industry, where public market investors are still struggling to find the right price point for stocks, there is perhaps an extra reason to worry. After all, the more share prices are liable to fluctuate, the greater the chances of a convertible bond being converted, raising the dilution risk for existing shareholders.
In order to protect existing shareholders, Nio included a call option capped at $14.92 – a 100% premium to the stock’s $7.46 Wednesday close. That allows the company to redeem the bonds with cash, instead of issuing new shares, at any time when its share price is below the cap price.
CREDIT BENCHMARK
Nio’s new convertible bond sale was also made difficult by the fact there are few, if any, credit benchmarks in the electric car industry, making harder for bond investors to determine fair value.
Tesla is the only sizable electric car maker but it is not directly comparable to Nio as it has already started mass production. The US firm produced 53,400 cars in the second quarter of 2018 alone, while Nio has delivered only 2,200 as of September last year.
According to a source familiar with the situation, bookrunners of the bond issue were guiding investors with a credit spread of 750 basis points over US Treasuries by comparing Nio with other US-listed Chinese firms.
However, some bond traders told FinanceAsia they assumed a much higher spread of about 900bp to 1,000bp.
The fairly wide range of credit assumptions was also due to the fact the company is yet to commercialise its electric vehicles on a mass scale, suggesting it is unlikely to make a huge profit anytime soon.
Nio said it booked only $7 million in income on a $503 million loss in the first half of 2018. It also reported negative cash flows of $461 million.
TERMS
In the face of these challenges, Nio ended up paying a slightly higher price on the convertible bond issue.
In a rare case, the final coupon of the five-year/three-year put bond was fixed at 4.5%, which was outside the initial guidance of 3.5% to 4%. That suggests Nio is paying 50bp – or at least $9.75 million over a three-year period – more than what it had expected.
Unsurprisingly, the conversion premium was set at the best-end for investors within the 27.5% to 32.5% range. That translated to a $9.51 strike price. The $100 million upsize option was not exercised at the time of pricing.
Based on a credit spread assumption of 750bp over Treasuries, the new deal has a fair value of about 105 to 107, a bond floor of around 85 and an implied volatility of around 40%.
According to the source, Nio was able to tap the convertible bond funding after its IPO bookrunners agreed to waive the six-month lockup restriction on share sales, which would have expired on March 11.
Tencent and Hillhouse Capital, both existing shareholders of Nio, committed to buying $30 million and $5 million of the new bonds, respectively, after the company conducted a wall-crossing exercise to a targeted group of potential investors since last week, according to the source familiar with the situation.
Despite paying a higher credit cost, Nio appeared to have gained confidence from stock market investors as its share price soared by 7.5% in Wednesday trading as the extended bookbuild was conducted, adding more than $500 million to its market value. The market was bullish about the fundraising exercise because it would solve Nio’s funding needs in the short term.
The Reg S/144A transaction is the third equity-linked issue in Asia ex-Japan this year after deals by Chinese school operator Yuhua Education and technology giant Lenovo.
Active bookrunners of the bond sale were Credit Suisse, JP Morgan, Morgan Stanley and Goldman Sachs. Passive bookrunners were Bank of America Merrill Lynch, Citigroup, Deutsche Bank and UBS.
