At HK$11.7 billion ($1.5 billion), Sinopec is by far the largest among the five issues that have come to market since last Tuesday and the biggest CB by a Chinese issuer ever. According to Dealogic, it also ranks as the largest equity-linked issue in Asia ex-Japan in almost six years, behind a $2.66 billion issue by Hutchison Whampoa in January 2001 that was exchangeable into Vodafone shares.
Such a large size is perhaps fitting for AsiaÆs largest oil refiner, especially since it hasnÆt been back to the international capital markets since it listed in October 2000, but some CB specialists say the size had to be compensated by a cheaper pricing. Not everyone was willing to call it cheap though û in fact some investors were said to have been arguing that, relative to an outstanding CB for offshore oil producer CNOOC, the pricing was more aggressive.
In any case, investors clearly saw good value as they piled into the deal. According to sources, the deal was more than four times covered when the books closed at 4pm Hong Kong time yesterday, suggesting more than $6 billion worth of demand. More than 150 investors submitted orders, with some asking for as much as $250 million each.
The Hong Kong-dollar denominated bonds have a seven-year maturity and pay no coupon, but can be put back to the company after four years for a 2.75% yield. There is an issuer call after four years as well, subject to a 130% hurdle. Lehman Brothers was sole global coordinator for the offering and acted as joint bookrunner together with Goldman Sachs.
While Goldman is well-known for its ability to get leading roles on high-profile deals like this one, the mandate is something of a coup for Lehman Brothers, which is still working on establishing a long-term presence in the public market for equity and equity-linked issuance in Asia ex-Japan. As of the end of last week, the US investment bank didnÆt feature in the top 10 on the league table for either straight equity or equity-linked issuance.
That will soon change, however, as aside from this CB Lehman is also one of five bookrunners for the $3.7 billion H-share portion of China Citic BankÆs dual listing, which is set to price on Friday this week.
SinopecÆs CB wasnÆt put up for a competitive bidding process among the investment banks, but rather was awarded on a relationship basis. Still, it is a sizeable deal to be done by only two bookrunners no matter how the mandates were awarded.
Unlike with most convertibles from Asian issuers these days, it wasnÆt the equity story that was the primary attraction of the Sinopec bonds û in fact some analysts are starting to turn more negative on the companyÆs earnings growth prospects after a very strong first quarter û but rather the technical aspects of the bond and the high quality of the credit.
ôIt is a liquid, hedgeable bluechip credit for China that is reasonably priced û whatÆs there not to like?ö asked one observer rhetorically. ôIt is a must-own trade for any CB-focused investor.ö
One source close to the deal confirmed that the majority of the issue had indeed been bought by technical investors and CB specialists, with straight long-only funds taking only a minor part of the offering. The high conversion premium is likely to have contributed to this outcome, they note.
The premium was fixed at 50% over MondayÆs closing price of HK$7.17 for an initial conversion price of HK$10.76. The premium came at the top end of an indicated range that started at 45% and was equal to that used on a $500 million exchangeable into property developer China Overseas Land and Investment the night before. It also matches the highest premium ever used on a CB for a Hong Kong-listed company.
While the issuer was said to have wanted a 50% premium, the yield was kept in the middle of the 2.5% to 3% range. In the words of the source close to the deal, this was to ôensure a better after-market performanceö as the company was keen to make its first transaction to international investors in almost seven years a successful one.
While clearly on the high side, CB specialists werenÆt too concerned about the conversion premium since the widely available stock borrow means it can easily be hedged. Rather, they focused on the implied volatility. At a 2.75% yield this came out at 30%, which marks a discount of 4 percentage points to the 100-day historic volatility at 34% and is on the cheap side, they say. At a volatility of 34%, the theoretical value of the bonds was estimated at about 101.5%, suggesting that the fair value at the final price was even higher.
By comparison, a day earlier the China Overseas Land exchangeable, which has a slightly longer effective maturity of five years, was priced with an implied volatility of around 40%.
One observer notes that no mater what volatility measure you look at for Sinopec, be it 260-day, 100-day or even shorter, none have gone below 30% for the past three to four months. At present, the 260-day volatility is about 35%.
ôI think they played it right, making it look cheap on the wide end to get people into the book and then get the momentum to tighten the pricing,ö he says.
According to market participants, the bonds were trading slightly above par in the gray market after the price was fixed last night.
The underlying assumptions included a bond floor of 92.5% which was based on a credit spread of 30 basis points. The bookrunners were said to have provided a significant amount of credit default swaps to back up this spread, although it was unclear how much had been taken up given that this is a liquid credit that can easily be hedged in the market. The stock borrow cost was set at 35 basis points and investors will get compensated if the dividend payouts grow by more than 10% per year.
The company told investors that it will use the proceeds from the CB to repay existing foreign currency loans taken up in connection with the earlier privatisation of Beijing Yanhua Petrochemical Co and Sinopec Zhenhai Refining & Chemical Co. One analyst following the company say this should help lower SinopecÆs interest expenses, which will be positive for the bottom line.
SinopecÆs earnings have been on a rise already as lower crude oil prices in the first quarter this year has been positive for its refining margins. In a statement published on the Hong Kong stock exchange website on Monday, the companyÆs net profit more than doubled to Rmb19.4 billion ($2.5 billion) in the first quarter. According to local media, the company said in a separate statement to the Shanghai stock exchange that it expects the profit in the six months to June to increase by more than 50% from the Rmb20.7 billion ($2.7 billion) it earned in the same period last year.
Expectations of a strong first quarter result had helped drive the share price higher over the past six weeks after being on a downtrend for the first two months of the year. The stock closed at a record high of HK$7.43 on April 11 and even at MondayÆs closing price of HK$7.17 it was up 46% higher than a year ago. The stock was suspended yesterday to allow the CB to be launched at 7.30am Hong Kong time.
Analysts are split on where the stock, and oil prices, will head from here.
Gideon Lo, an oil sector analyst at DBS Vickers, expects average crude prices to be lower in 2007 than in 2006 and says this should support a further improvement in SinopecÆs refining margins and chemical earnings. A forward price-to-earnings ratio below 10 times means there is room for improvement, especially since Sinopec is trading at a discount to both PetroChina and CNOOC, he says.
However, UBS last week cut its recommendation on Sinopec to ôreduceö on the back on expectations that oil prices will rebound, and yesterday Citi downgraded its rating on the stock to ôsell.ö The US investment bank, which has recently dropped the word ôgroupö from its name, said in a report that valuations are near an all-time high, while the earnings momentum is turning negative.
ôEven relative to the index, Sinopec is not cheap, trading at a 39% discount to MSCI-China, compared to an average of 41%,ö Citi said in a report.
Such talk seemed to matter little for investors faced with the option of whether to buy the Sinopec CB or not, however, as the ample liquidity in the market and the strong, liquid credit overshadowed the equity story. It will be interesting to see how the interest will stack up for the next few convertibles that are expected to hit the market over the coming few weeks, however. Observers say it is likely that ôthe right priceö will become increasingly important as another of the key drivers of demand over the past couple of months û scarcity û is becoming less of an issue after the flood of issuance this past week.
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