China Unicom breaks record with $1.8 billion CB

China Unicom on Monday did its part to maintain the recent positive momentum in the Asian convertible bond market by pricing a $1.838 billion deal that attracted strong demand from both hedge funds and outright investors, and proceeded to trade well in the aftermarket. The bonds are convertible either into common shares listed in Hong Kong or into Unicom’s American depositary shares which trade on the New York Stock Exchange.

The five-put three deal is the largest CB ever in Asia ex-Japan, exceeding the $1.5 billion offering by China Petroleum and Chemical Corp (Sinopec) in April 2007, and the largest equity-linked bond in the region in almost 10 years behind Hutchison Whampoa’s $2.66 billion issue in January 2001 that was exchangeable into Vodafone shares.

The deal was also large relative to the trading volume in Unicom’s Hong Kong-listed stock, which average no more than $50 million a day. Despite the size, the three bookrunners were able to push the coupon and conversion premium to the mid-point of the indicated ranges and to ensure a healthy take-up without leaving too much on the table. The deal was said to have been about two times covered at the final terms and to have attracted more than 150 investors, which is a clear indication that there is depth in the market for the right deals.

One CB specialist noted that a transaction of this size is almost a “must-own” deal and there has also been very little CB issuance by investment grade names this year, as most of them have chosen to issue straight bonds instead. And deals in the telecom sector are an even greater rarity. But Unicom also did tick pretty much all the boxes in terms of what makes for a successful CB. A state-controlled company, Unicom is a strong credit – some referred to it as a quasi-sovereign – and being the only mobile operator to sell Apple’s popular iPhone in China, the equity story is pretty appealing as well. And on top of that, there is plenty of stock borrow available in the market at a low cost, making the CB attractive for hedge funds who want to play the volatility.

However, the issuer refrained from pushing investors too much and sources said the fact that the deal came with a small coupon helped ensure good support from outright accounts. As of late afternoon yesterday (Hong Kong time) the bonds were trading at about 101.25-101.50, suggesting that this was a good deal both for Unicom and the investors.

The bonds were offered with a coupon ranging from 0.5% to 1.0% and a conversion premium of 33% to 38% over Monday’s closing price of HK$11.70. Both were fixed at the mid-point, resulting in a 0.75% coupon and a 35.5% conversion premium. The latter is one of the highest premiums in Asia all year and allowed Unicom to achieve one of its key objectives, which was to ensure the conversion price was above the HK$15.58 price at which it sold shares in its Hong Kong initial public offering 10 years ago. With a 35.5% premium, the initial conversion price ended up at HK$15.85, or at $20.43 per ADS.

A second objective for the company was for the deal to be large enough to allow it to issue 900 million new shares if the bonds are converted. The significance of that number is that Unicom in the fourth quarter last year bought back close to 900 million shares, or 3.8% of its existing share capital, from SK Telecom, and while those shares were subsequently cancelled, the company seemingly felt that it would be able to re-issue that same number of shares without having to face complaints in the market about dilution.

“This is a very smart trade. Essentially the company bought back shares at a lower price (HK$11.105 per share) and are now selling them at a premium to market, at a carry of just 75bp,” said one source.

For the bookrunners – China International Capital Corp, Goldman Sachs and Nomura – another key issue was to finish the deal before the US market opened so as to avoid having to market the offering against a live share price. This turned out not to be that big an issue as the deal was covered quite quickly after the launch at around 6.30pm on Monday (Hong Kong time). The books eventually closed at 9pm, although it then took the best part of the night to sort out the allocations. 

According to sources, the demand was fairly evenly split between hedge funds and outright investors, with some overweight towards the former.

Unicom’s ADSs fell 5.8% on Monday in the wake of the deal, which was slightly more than the 5% slide that most investors worked into their models. But the Hong Kong-listed shares held up slightly better, declining 4.3% to $11.20, and last night the ADSs too recovered some of the lost ground. At the end of US trading, Unicom was up 1.8% at $14.54, while the Dow Jones Industrial Average finished a mere 0.4% higher amid concerns about a dip in consumer confidence.

The Unicom CB was marketed at a credit spread of 100bp to 150bp, which is in line with other state-owned Chinese CB issuers like Sinopec and CNOOC. According to market participants there were some three-year credit default swaps (CDS) available on Unicom in the market after the deal at 150bp. The stock borrow cost was assumed at about 50bp and investors will be compensated in full for any dividend payments.

At the wide end of the spread this gave an implied volatility in the low 20s and a bond floor at around 95%. At a spread of 100bp, the implied vol would drop to about 18%.

The bonds come with an issuer call option after three years, subject to the usual 130% trigger.

In an announcement filed with the Hong Kong stock exchange yesterday, Unicom said the CB will provide strong capital support as it continues to develop its key businesses, including 3G and broadband, and will also enhance its market presence and competitiveness. And there are holes to fill. Analysts note the company’s heavy capex programme as it competes with China Mobile and China Telecom to build out its 3G network to capture more mobile subscribers, as well as its quite weak cashflow. Unicom, which is the second largest mobile operator in China after China Mobile, also provides fixed-line services.

The 3G business is still at an initial stage of operations and in the first half of this year, the company’s net profit fell 62% to Rmb2.53 billion ($377 million) as the revenues from this business was insufficient to cover the costs for operations, maintenance, asset depreciation and marketing.