AES China Generating Company priced a $175 million seven-year Reg S eurobond after Asia's close yesterday (Thursday) via lead manager UBS and joint lead Deutsche Bank.
The deal was viewed as a particularly challenging one by most market participants given that it had to contend with the double whammy of an opaque and difficult operating environment in China combined with problems at the borrower's overleveraged parent, US based AES Corp. Nevertheless, in a testament to the liquidity of the Asian credit markets and investors' desire for yield, the deal was successfully priced and accounts seemed prepared to accept a significant watering down in covenants.
The transaction was priced at 99.348% on a coupon of 8.25% to yield 8.375%. It is callable from year three on a sliding scale that starts at 103.5% and finishes at par by the end of year six. In terms of spread, it was priced at 500bp over 10-year Treasuries, or 611bp over five-year. Fees total 1.5%.
Unlike the original deal led by Morgan Stanley, the new deal was targeted at an Asian rather than US audience. With an order book that closed around the $450 million mark, a total of 70 accounts participated.
By geography, the book split 42% Singapore, 31% Europe, 14% Hong Kong and 13% offshore US. By investor type, asset managers took 45%, private banks 40% and banks 15%.
Company president Haresh Jaisinghani says he was pleased with the result. "We have a transaction, which falls due in December 2006 and wanted to re-finance it via the call option," he comments. "We came to the market now because we believe the general interest rate environment is very good for this kind of bond. And also there hasn't been much paper from China or from our sector for a very long time, so we expected demand to be solid."
Proceeds from the new bond will be held in an escrow account until final completion at which point the original 10.125% December 2006 bond will be called at 102.351%. This $180 million deal was priced in December 1996 at 99.90% to yield 375bp over Treasuries. It has a call schedule, which kicked in at the end of year five at 105.063% on a sliding scale to par in 2006.
Over the past year, it has had an erratic trading history, veering from a low of about 650bp over Treasuries in January 2002 to a high of 1,000bp in June the same year. Over the past month as news of the deal began to filter out, it started trading up from a cash price below just below par to the call price. On a yield basis, it was ranging from 9.5% to 10%.
One of the major differences between the old and new bond is the rating assigned by Moody's. The original deal was rated B+/B1, while the new deal has a B+/B2 rating. The company's parent AES is rated one notch lower again by Moody's at the B3 level.
The main reason appears to be the weaker covenants attached to the new deal. During roadshows the company argued that whereas the 1996 transaction was more of a project finance bond, the new one reflects a company with an operational history and is therefore deserving of less restrictive covenants. Its main gripe appears to be that the former deal resulted in too much dead cash ending up trapped at the China parent level, which incurred a negative carry and could have been put to better use elsewhere.
Investors worried that this 'better use' would entail draining AES China profits by sending dividends up the US parent to help pay off some of its huge debts. Under the terms of the 1996 deal, the company was capped at 50% of net profits. According to UBS research, the company came very close to the cap in 2002 when it paid out $25 million and ranked 15th in payments to the parent over the course of the same year.
The new deal has no cap at all and Jaisinghani declines to comment on whether this means an increased pay-out ratio. "I cannot give out projections about dividend payments, but I can say that they will be a lot more smooth than before," he explains.
But observers also point out that should AES China make a restricted payment including dividends, it will place cash equivalent to six months of debt service payments into a reserve account. Previously it had to maintain this level of cash in a reserve account the whole time. It can also only pay dividends if it satisfies the ratio test - a fixed charge coverage ratio starting at 1.5 times and rising to 2 times, with a calculation based on cash flow at the parent net of expenses divided by debt servicing costs.
Other investor concerns were linked to the likelihood that AES Corp will force asset sales on its Chinese subsidiary. Here investors are protected to the extent that the company will be forced to buy back the whole deal if it sells either of its two biggest assets - Jiaozuo and Yangcheng (68% of forecast 2003 cash flow).
However, Jaisinghani says that the company's intention is to expand rather than contract its asset base. And he adds, "While there are no opportunities we're pursuing right now, we do have a desire to grow."
UBS research says that the company currently operates gencos in six Chinese provinces with equity interests of 25% to 70% in seven projects. These have an aggregate capacity of MW2,855 and concession periods ranging from 16 to 30 years.
All of the project's offtakers are either provincial or municipal governments and a number have failed to deliver their contracted payments. But as Jaisinghani stresses, "There's not really any outstanding disputes at the moment and we've previously reached successful settlements either on a bi-lateral basis or through arbitration. It's part and parcel of doing business in China and the key is being able to manage it."
He also comments that rising demand for electricity in China has led offtakers to make more than the minimum contracted.
"We're very pleased with our new bond," he concludes. "We re-financed on a lower coupon and broadened our investor base. It's good that we targeted Asia this time round. It gives our credit visibility and increases investor awareness. It's important for our future in Asia."
