The companyÆs expansion both upstream, through the acquisition of purchase rights from an iron-nickel mine in Indonesia, and in the mid- and downstream segment of the market, through the addition of its stainless steel business, is already paying off with a five-fold increase in its first half net profit. And analysts are expecting further strong earnings growth and a continued re-rating of the share price as this transformation continues.
Given that the CB provides investors with a chance to participate in this potential equity upside while offering protection on the downside, it came as no surprise that the deal was heavily subscribed. The thin amount of new CB issuance since the subprime-related correction in August may also have played a role as investors are starved for paper. It is worth noting that this is the first Hong Kong dollar-denominated convertible of size since New Word DevelopmentÆs HK$6 billion issue in mid-May. The only other deal since then was a HK$650 million offering for China Water in mid-July.
ôThere is some scarcity, but this is primarily an interesting growth story. People buy these trades as a safe way to play the equity,ö notes one observer.
According to sources, the total order amount was well over $1 billion or more than five times the bonds available under the HK$1.5 billion ($192 million) base offering, which prompted joint bookrunners Credit Suisse and Deutsche bank to exercise the HK$500 million upsize option straight away. Approximately 80-90 investors participated in the offering, which wasnÆt launched until about 5.30pm Hong Kong time, even though the stock was suspended from trading during the afternoon session.
The demand was very similar to that seen on Monday for the $250 million CB issued by Indian telecom tower operator GTL Infrastructure. That deal too was said to have attracted more than $1 billion of demand from about 90 investors.
The premium on China NickelÆs offering was, however, fixed towards the low end of the offering range and the yield was kept at the mid-point, suggesting there was some price sensitivity. Sources close to the deal said the company also wanted to leave something on the table for investors, but the fact that the bonds were said to be bid only marginally higher in the grey market at 100.25 last night, suggests that investors thought the price was fair û or at least not too cheap.
The zero-coupon bonds were offered with a conversion premium of 35% to 40% over the latest closing price of HK$4.24 and were sold with a 36% premium. The yield to put was fixed at 5.5% after being offered at 5.25% to 5.75%.
The bonds have a five-year maturity, but can be put back to the company after three years. There is also an issuer call after three years, subject to a 130% hurdle.
The underlying assumptions included a credit spread of 350 basis points over Libor. Investors were offered asset swaps for about 20% of the deal at that level, which were said to have been provided by Credit Suisse. While it wasnÆt entirely clear whether Deutsche too provided a credit bid, the strong demand suggests that further credit support wasnÆt really needed and most investors would have bought the bonds for the equity story anyway.
The stock borrow cost was assumed at 5% and the bondholders will be compensated for cash dividend payouts that exceed a 35% yield. At the final terms, this gave a bond floor of about 93.8% and an implied volatility of about 33%-34%.
China NickelÆs share price has rallied about 245% so far this year in response to the expansion of its business and last month Goldbond and CCB International both initiated coverage of the stock with target prices of HK$6.08 and HK$5.50, respectively. This indicates a belief that the share price will climb another 30% to 43% over the next 12 months.
The key to achieving this will be the successful execution of its integrated strategy. Having previously focused primarily on the production of bearing steel and spring steel, China NickelÆs move into more value-added products earlier this year is already having a significant impact on gross margins, which expanded to 33% in the first half from 23% a year earlier. Contributing strongly to this was the exclusive 14-year off-take agreement that the company secured in May that will allow it to buy 40 million tonnes of iron-nickel ore from the mine in Indonesia at a low fixed price of $16 per tonne, thus keeping its raw material cost under control.
On the revenue side, China Nickel, which changed names from China Special Steel Holdings earlier this summer to reflect its change of business focus, is planning to increase its melting capacity in China from one million tonnes per year at present to three million tonnes through the construction of new plants, new leases, or through further acquisitions. It is also planning to set up a new steel plant in Indonesia with a designed annual melting capacity of three million tonnes to save on transportation costs and to open up the Southeast Asian market.
According to a Goldbond report, these plans will require capex investments of Rmb2 billion ($268 million) and together with the Rmb1 billion that it currently holds in cash, the CB proceeds should cover that.
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