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United Laboratories International, a Hong Kong-listed Chinese manufacturer of generic Western drugs, yesterday raised Rmb790 million ($125 million) from the sale of convertible bonds. Being the first Asian CB since Rexlot Holdings’ $105 million Hong Kong dollar-denominated deal on September 21 and only the second trade since early August, the deal attracted a lot of attention as market participants look for a possible reopening of the CB market.
True, Temasek Holdings issued S$650 million ($513 million) worth of bonds exchangeable into Standard Chartered shares in mid-October, but given Temasek’s unique triple-A rating, that deal, while successful, was seen to have little bearing for the overall equity-linked market.
At first glance, the United Labs CB looked pretty attractive, coming as it did with a decent coupon and a conversion premium that wasn’t too demanding. But it was also marketed with two upsize options that together could have increased the deal size by more than 50%, which did appear to spook potential buyers a little bit. There was also some confusion early on about the availability of asset swaps. According to sources, the bookrunner did provide asset swaps for about 30% of the deal at 900bp over the interbank offered rate, which was at the tight end of the credit assumptions. Some CB specialists assumed a spread as wide as 1,300bp to 1,500bp, while others said 1,100 was the more appropriate level. Either way, some investors were left disappointed as they were unable to get as much swaps as they wanted, or indeed, any at all.
These issues, together with a sell-off in European equity markets during the bookbuilding, pushed the CB below par in the grey market. At one point, it changed hands as low as 98, but after pricing and as Europe rebounded somewhat, it traded up to about 99. Still, it was not the positive signal that market participants may have hoped for and based on the initial response, this deal is unlikely to trigger a wave of new CB issuance.
Market participants also took the early trading as a sign that the deal wasn’t distributed in full and said HSBC, as the sole bookrunner, was likely left holding some bonds. Sources close to the deal had no comment on that, but did note that there was a substantial shadow book already at launch. (It seems the shadow book was partially built on the premise of getting asset swaps, but that swaps may not have been offered to other investors). The first upsize option of Rmb210 million that could only be used together with the base deal was not exercised, but the there is also a second upsize option of Rmb200 million ($32 million) that can be exercised within the next 30 days.
The CB, which is denominated in renminbi but settled in US dollars, has a five-year maturity, but comes with a short two-year put option at par and a two-year call, subject to a 140% trigger. It was offered with a coupon and yield between 6.5% and 7.5% and a conversion premium ranging from 20% to 30% over the latest market price of HK$6. They were both fixed at the investor friendly end, resulting in a 7.5% coupon and a 20% premium.
This gave a conversion price of HK$7.20, which doesn’t look particularly steep. In fact, United Labs’ share price has fallen about 60% from around HK$16 since the beginning of this year and several analysts argue that the current share price represents good value. The company’s earnings fell in the first half of the year as raw material costs increased and China introduced a price reduction policy on medicines and restricted uses of antibiotics by medical institutions at all levels. The latter created a wait-and-see atmosphere in the market and indirectly influenced the demands of bulk medicine products.
In its six-month earnings report, the company noted that approximately 60% of the antibiotics made by the group are classified as non-restricted categories, and said it expects its sales of finished products to gradually pick up in the second half of the year as the restrictive measures become clearer. It also said that it will continue to expand its business.
According to the term sheet, United Labs will use the CB proceeds to refinance existing borrowings and to fund planned capital expenditures. The company’s main business is to manufacture and sell finished antibiotics drugs as well as the bulk medicine and intermediate products used to produce them.
The chairman, who is also the controlling shareholder, supported the deal by lending shares to HSBC, which were then passed on to the CB buyers to enable them to hedge the equity option. The shares were made available at a cost of 1.5% and there was said to be enough on offer to cover the delta.
Assuming a historic volatility of 35% — the realised historic vol — is actually above 60%, a credit spread of 900bp to 950bp and a full cash dividend protection, the CB is valued with a bond floor of 95.25% and an implied vol of just 4.3%. The theoretical value worked out at about 111.5, which made it even more surprising that the CB traded down in the grey.
The initial plan seemed to be to have most of the deal done by the time European trading opened, so as to reduce the price risk. Hence the stock was suspended from afternoon trading and the order books opened at 1.30pm Hong Kong time. The bookrunner stopped taking orders from Asia at 4pm, but kept the European order books open until 6pm.
The deal was said to be anchored by hedge funds, but with some demand from long-only funds and private banking investors. The number of orders were said to have been fewer than 20.
In light of the high estimated theoretical value of the bond and the generally positive view on the company, the CB certainly has potential to trade higher in the aftermarket. Indeed, some observers said they see value even at a significantly wider credit spread. Whether there will be enough demand to exercise the upsize option remains to be seen.
