Chaoda raises $356 million from CB/placement combination

Hong Kong-listed Chaoda Modern Agriculture has raised $356 million from a combined sale of new shares, convertible bonds and warrants that it said it will use to expand existing production areas and to establish new ones in different parts of China.

The deal, which was initially offered as a package to a small group of 10-15 anchor investors but later opened up to a wider audience, attracted attention partly because the $200 million CB portion looked cheap – or at least very attractive for investors. Or how else can one describe a CB that can be converted into equity at a discount to the latest closing price?

It ended up at a discount because the conversion premium was fixed at a mere 7.5% over the share placement price which was already at a 12% discount to Friday’s close of HK$8.56. With the stock suspended both on Monday and yesterday, the share price hasn’t yet reacted to the transaction, which will result in a dilution of about 14.1% for existing shareholders if the CB and warrants are converted in full. But it is likely that the share price will drop and turn the discount into a conversion premium. The deal was also offered as a package, meaning investors who bought the CB had to buy the equity and the warrants as well – although it was possible to buy just the equity.

Even so, it comes as no surprise that there was good demand for the CB, especially since the agricultural sector is hot at the moment with prices rising across products, and China-based Chaoda, which grows fruits, vegetables and crops, breeds livestock and operates a supermarket chain, was able to exercise most of a $60 million upsize option to increase the size of the CB to $200 million from $150 million.

The equity portion, which also featured a $60 million upsize option, was kept at the original size of $150 million, while the three-year warrants brought it $6 million. If they are exercised in full, the warrants could later result in another $105 million of gross proceeds for the company. In a filing to the Hong Kong stock exchange, Chaoda said the combined offering allowed it to raise funds while at the same time broadening both its shareholder base and capital base.

The deal was clearly structured to attract maximum demand from investors and this was further emphasized by the fact that the placement was priced at the bottom of the indicated range, the conversion premium on the CB was set at the wide end, and the strike price on the equity-like warrants is only 5% above the placement price. This means that the American-style (they can be exercised pretty much at any time during their three-year life) covered warrants can be turned into equity at a price of HK$7.9065 per share – a 7.6% discount versus last Friday’s closing price of HK$8.56.

Chaoda offered about 154.8 million shares through a top-up placement at a price between HK$7.53 and HK$7.87, which represented a discount of 8% to 12% versus Friday’s close. The final price of HK$7.53 was then used as the reference price for the CB and the warrants.

The CB has a five-year maturity, but can be put back to the issuer at par after three years, subject to a 130% hurdle. There is also an issuer call after two years. It was offered with a coupon between 3.25% and 3.9%, which was later finalised at 3.7%. Since the bonds are issued and redeemed at par, the yield is also 3.7%. As mentioned, the conversion premium was fixed at the bottom of the 7.5% to 20% range for an initial conversion price of HK$8.10, or a 5.4% discount versus the latest close.

Because it was primarily sold as a private placement, there were little information available about who bought the deal, but sources said the equity and CB portions were both well covered.

The bookrunners approached potential anchor investors on Monday after the stock was suspended and the deal was opened up to additional investors later in the day. The pricing and the decision to upsize the CB was said to have been finalised late Monday, although details of the transaction didn’t really emerge until yesterday morning.

While the shares remained suspended yesterday, market participants said the CB was quoted at about 107-108 during Asian trading. However, observers noted that it was difficult to value the bonds properly until it was clear how much the equity would slip and the price is likely to adjust to that reality today.

Based on a credit spread of about 700bp to 800bp, where there were supposedly some credit default swaps available on Chaoda, a 1% dividend yield protection (this was changed from an initial suggestion of a full dividend pass through) and a stock borrow cost of 75bp, the implied volatility would end up in the low- to mid-teens, according to a source. The bond floor would be in the mid- to high 80s. However, given that it was a package deal with an equity portion as well, investors are likely to have focused primarily on the equity story.

This is the second concurrent CB and placement transaction by a Hong Kong-listed company in a month, following a successful $701 million deal in July for China Agri-Industries Holdings, a producer and supplier of processed agricultural products, including biofuels, edible oils and rice. China Agri also roped in investors through an attractively priced CB, although the effective conversion premium versus the latest close on that deal was still 19.7%.

Indeed, the fact that the CB investors were also forced to buy the equity makes the Chaoda transaction more similar to the two concurrent CB and equity deals that were done for Indian companies Larsen & Toubro and Tata Motors in October last year. Both these deals were using investor friendly CBs as a way to force investors to also buy new shares that were priced at a tight discount due to the floor price regulations. Citi, which acted as sole bookrunner on the Chaoda transaction, also structured and arranged the Larsen & Toubro deal and was a joint bookrunner together with Credit Suisse and J.P. Morgan on the Tata Motors trade the following day.

However, both Larsen & Toubro and Tata Motors still featured conversion premiums versus the latest close of 18% and 5.9% respectively. And given the wide discount on the placement portion, it is somewhat surprising that Chaoda felt that it needed to offer the CB at such generous terms. The company has no other debt after repaying a $225 million high-yield bond in February this year and is generating strong cash flow from its business. In the past, the share price has been weighed down by corporate governance concerns – among other things the company has had five auditors since 2001 -- but the management has worked to improve the situation and the stock has come back into favour among investors.

In the past 12 months the share price has increased by 93% and in April, Moody’s upgraded the company’s rating to Ba2 from Ba3, leaving it just two notches below investment grade. Standard & Poor’s rates it one notch lower at BB-, although with a positive outlook. The CB does not have a separate rating.

One CB specialist said that while it is clearly unusual that CBs are offered with an effective conversion discount, the pricing of Asian deals are getting more and more similar to those in Europe and the US and it is no longer uncommon that they come at terms that allow the bonds to trade up to 102 or 103 in the immediate aftermarket. China Agri rose to about 105-106 in the first couple of sessions.

“If (the terms) enabled the company to raise more than $400 million, then that is positive,” he said of the Chaoda transaction.

In a credit opinion issued in April, Moody’s said the Ba2 rating reflects Chaoda’s leading market position and large-scale vertically integrated business model with diversified production bases and distribution networks, as well as the Chinese government’s favourable agricultural policy, which ensure “lucrative margins and strong growth momentum”.

The rating agency noted that the company has “sufficient balance sheet liquidity to meet its large capex plan” but added that while Chaoda’s financial profile is stronger than other Ba credits in the region, “its rating is constrained by qualitative issues such as unpredictable financial management strategy, frequent change of auditors and potential concerns over corporate governance, given the existence of material related-party transactions and the cash nature of its business model.”

Chaoda is currently owned to about 20.1% by its chairman Kwok Ho, although his stake will fall to 17.7% if the CB and warrants are exercised in full and following the top-up share placement where he provided the sale shares and then subscribed to the same number of new shares.

Photo provided by AFP.