Asia Aluminum bond tender at risk of rejection

Asia Aluminum's ongoing tender offer for all its outstanding international bonds and notes has met with resistance from investors, to the extent that the offer could possibly fail. Some say such an outcome would be positive for Asia's high-yield market as it would show that investors are prepared to fight for their rights, but it would arguably also cast doubt over any future restructuring attempts in Asia.

The emotional tug-of-war heated up on Friday when Asia Aluminum's founding chairman essentially offered to give away the entire company to the bondholders if they could come up with a better solution.

Some holders of the Chinese aluminium producer's $450 million 8% bonds due 2011 argue simply that the offer price is too low, which is not all that surprising for an offer at 27.5 cents on the dollar. After all, there is always a chance that the suggestion of a tender failure could result in a higher offer from the issuer.

More interestingly, though, the bondholders are arguing that their seniority as credit providers is not being honoured to the extent that it should. And on top of that, there is a feeling both among some of the bondholders and the holders of $535 million worth of Payment in Kind (PIK) notes that were issued by holding company AA Investments Company to finance a privatisation of the company in 2006, that the foreign creditors are ending up with the short straw here. What they want to see is a solution to Asia Aluminum's current cash problems that will allow the foreign creditors a chance to remain part of the company post a restructuring.

Specifically they have noted that founding chairman Kwong Wui-chun will emerge from the proposed restructuring with 30% of the equity, while the management will end up with 10% and the local government with 25% at no cost (in return for providing a new loan). Local banks will also take no haircut on their outstanding loans, while the bondholders and the PIK note holders are being asked to accept principal losses of 72.5% and 86.5% respectively.

The foreign creditors are also put off by the fact that the issuer had not discussed the situation with the offshore creditors before making the tender offer, and yet they are being told that their acceptance of the offer is basically the only way to keep the company out of bankruptcy. One creditor who spoke with FinanceAsia said this ultimatum is even more off-putting since the company has not been able to get its auditors to sign off on the latest financial results, making it difficult to know whether the gloomy picture it paints is really correct.

At a conference call arranged last week by Emerging Market Trade Association (EMTA), an organisation dedicated to promoting the orderly development of a fair, efficient and transparent market for trading emerging markets instruments, and Aberdeen Asset Management, holders of the 2011 Asia Aluminum bonds agreed not to participate in the offer, according to an analyst who participated in the call.

In a note issued to clients, bond analyst Warut Promboon, who runs his own credit research platform under the name of bondcritic.com, said the bondholders are contemplating forming a steering committee to approach chairman Kwong and the local Chinese government to voice their opinion on the offer.

Putting into writing what several other market participants are saying, Promboon says a successful tender will "shut the door for the Chinese high yield market" although he also acknowledges that a rejection of the tender will likely result in Asia Aluminum defaulting. He estimates that the liquidation value will be no more than 20 cents, but says a 7.5 cent loss to the dollar could be worth the fight for a restructuring or even a better concession price.

"A fight by investors will warn off other issuers not to follow suit," he adds.

Clearly, investors are worried about the fact that there are plenty of Asian companies that are too highly leveraged for the current market environment and which are finding it increasingly difficult to get sufficient capital to carry out their day-to-day operations -- let alone finance any expansion plans. And their objections to the tender are not without merit when considered in the context of other restructurings.

The claim that the holders of the deeply subordinated PIK notes are getting too big a slice of the repayment at the bondholders' expense, is for instance, backed up by a Credit Suisse research report, which argues that the offer to the Asia Aluminum bondholders "shows little reflection of the seniority of their claims over holding company creditors and shareholders. In theory, the shareholders and holding company lenders should get completely wiped out before (the Asia Aluminum) lenders are asked to give up anything."

Credit Suisse analyst Damien Wood estimates that by re-jigging the offer and reducing the payment at the holding company level -- i.e. to the PIK noteholders -- to 5 cents on the dollar, the bondholders could get 41 cents. And if the repayment were also to include a big chunk of the equity that is being retained by the chairman and that which is being allocated to the management or set aside for future shareholders, then the offer to the bondholders could be stepped up yet another notch.

Meanwhile, several market participants have noted that on similar restructurings in the US, PIK noteholders have typically not been asked to take a haircut without getting at least some equity in return. Another option would be to consolidate the various offshore borrowings into one debt structure that would improve the value of the credit.

Sources close to the company say that neither of these options is really possible in the case of Asia Aluminum, however. For one, the Chinese banks that have tentatively agreed to provide the company with a new Rmb6 billion ($879 million) loan -- if the tender offer is accepted -- want all the offshore debt cleared first. And second, the PIK note holders have to get paid a reasonable amount, because without their participation the deal will fail.

The company said in the tender offer document that it saw a significant decline in its cash balances in the second half of 2008 and by the end of the year had only HK$702.8 million of consolidated cash and bank balances due to a sharp decline in sales volumes, an increasing need for working capital to finance an ongoing flat-rolled product expansion project, as well as the tighter credit markets. It added that its bank creditors may demand immediate repayment of all outstanding amounts and refuse to approve further drawdowns under its existing working capital facilities should the tender offer not go through.

Aside from the decline in demand for aluminium and a delay in the commissioning of its new flat-rolled product plant, however, Asia Aluminum's current cashflow problem is also directly related to its aggressive addition of debt in connection with Kwong's leveraged buy-out two years ago - a debt that it is now finding increasingly difficult to service. The $500 million plus financing, which exceeded the company's $350 million market cap at the time, pushed its debt to Ebitda ratio to 13.3 times from seven.

To underline the precarious situation and stress that the talk of potential bankruptcy isn't an empty threat, chairman Kwong on Friday issued a letter to the bond and PIK noteholders in which he noted that since the beginning of last year he has "explored various rescue alternatives with the management, including active pursuits of equity investments from local and overseas industry leaders, the sale of part of our assets, and discussions with government bodies and financial institutions (regarding) any financing possibilities of capital injections and expansion of financing, with the aim of maintaining continuous operations and avoiding a liquidation of the company and the loss of over 10,000 jobs."

The outstanding tender proposal, he said, represents the most favourable results for investors that they were able to secure.

Showing his frustration over the criticism that he will still hold 30% after the tender, Kwong noted that he will discharge a loan of $61.2 million due to him by the group while also accepting a significantly reduced equity stake to 30% from 97.4% at present to help put the company in order.

"If investors still do not accept the offer, question my motives for putting forward this proposal...or even misinterpret this effort as a move to enhance my personal wealth, I would take this chance to formally announce that I would give away all my shares and interests in the group to investors," he said, adding that in return the investors will have to guarantee that the company must continue its operations, that employees will keep their jobs, that banks and suppliers will not incur any losses and that they will shoulder corporate social responsibilities.

There is of course no reason to believe that the bondholder will take him up on his offer, but again it demonstrates the emotional game that is being played.

Whether or not the deadlock can be eased this week as the company's financial advisory agent goes on the road to meet the bond and noteholders remains to be seen. If it doesn't and the investors follow through with their threat not to accept the offer by the early tender deadline on March 10, then there is a high likelihood that the company may withdraw the offer, sources say. Since the Asia Aluminum bonds are widely held, it may not be that easy to coordinate a joint approach, however, and market participants say retail investors in particular are expected to tender since the offer is currently above the price indicated in the market.

The company has hired PacBridge Capital Partners (HK) as a financial advisory agent -- a consultation firm set up by Merrill Lynch's former head of investment banking for Asia, Sheldon Trainor, and former Morgan Stanley executive director Brian McCullough. The pair has been involved with Asia Aluminum several times in the past and helped arrange the company's high-yield bond back in December 2004 when they were both at Morgan Stanley. Trainor was also involved in the leveraged buyout in 2006 when he was at Merrill.