Pre-marketing begins today (September 26) for a roughly $2.5 billion equity offering by Korean chip manufacturer Hynix Semiconductor. The transaction is being treated like a re-IPO and has a full marketing schedule embracing two weeks of pre-marketing and two weeks of roadshows, with pricing scheduled for around October 26.
Merrill Lynch is global co-ordinator of the deal and the only bank to act as a bookrunner on both the domestic and international tranches. The split between the two tranches has not yet been formalised, but specialists expect slightly more than half of the deal to be placed domestically. Alongside Merrill, domestic bookrunners comprise Daewoo, Good Morning and Woori Securities, while Citigroup, Credit Suisse First Boston and Deutsche Bank are running the international books.
The sale of a major stake by Hynix's domestic creditors has been expected for some time and follows the company's release from its Creditors Restructuring Promotion Act in July this year. Back in 2001, creditors took control of the company via a debt-for-equity swap after it succumbed to a $10 billion debt burden and industry downturn.
In July, it was able to release itself from this programme 18 months ahead of schedule after completing a $500 million high yield bond that formed the final piece of a $1.384 billion re-payment package.
In turn, this allowed the creditor group to begin the process of divesting their combined 81.4% stake. Under the terms of the sell down agreement, creditors can offload 30% upfront and the remaining 51% after December 2007.
However, once a six-month lock up attached to the GDR expires, all or part of the remaining stake can be sold if 75% of the 200 odd creditors agree. In addition to the creditors' stake, the new deal will also include a tranche of new equity for capex purposes, although the exact mix between primary and secondary shares has yet to be finalised.
Nevertheless, it is expected that the creditors will stay just above the 51% mark post deal - a key level, since they have been considering the sale of a strategic stake encompassing management control. Over the past year, there have been numerous rumours concerning potential acquirers ranging from archrival Samsung Electronics, or the LG group to the National Pension Fund and a consortium of domestic private equity investors.
This M&A fervour is one of a number of reasons why Hynix is trading at a premium to every single global DRAM player on a price to book basis. At its current price of Won22,800 per share, the world's second largest DRAM manufacturer is presently trading at a mid-cycle valuation of around 1.8 times 2005 book.
Only Samsung Electronics has greater market share in the DRAM sector, but its valuation of around 2.4 times book also embraces other business lines such as TFT-LCD. The nearest pure comparable is Micron of the US, trading around 1.45 times book. Smaller Taiwanese DRAM manufacturers such as ProMOS, Powerchip and Nan Ya are all hovering around book value.
On a PER basis, Hynix looks much cheaper at around 7.5 times 2005 earnings. At one end of the scale is Micron at 175 times 2005 earnings, followed by ProMOS at 80 times, Nan Ya 16 times and Powerchip 11 times.
Korea typically trades at a discount to tech heavy Taiwan, but recent trading patterns suggest this is starting to change. Hynix itself has had a phenomenal run over the past year, returning 119%. Year-to-date it is up 95.71% - double that of the Kospi.
The stellar performance of both the company and the index, have been partly driven by a renewed enthusiasm for Korean equity on the part of domestic retail investors. The origins and sustainability of this buying spree are examined in the September issue of FinanceAsia.
An article entitled: "The only way is up," concludes that there have been two key shifts in Korea - one away from saving to investing and one away from individual investing to professional money management. Since the end of 2003, for example, domestic retail investors have ploughed $9 billion into equity installment funds, which are now growing by around $500 million a month.
The most bullish local observers believe this secular upturn will see the Kospi jump from a current level around the 1,200 mark to 4,000 to 5,000 within three years. They also point out that at 12 times earnings, the index is still trading at less than half its 1999 level around 24 times.
Where Hynix is concerned, specialists believe the company will benefit from the current market dynamics in two ways. Firstly, the shareholding structure is very heavily weighted in favour of domestic investors who own about 90% of the freefloat. By contrast, foreign investors own about 40% of the Kospi as a whole.
Specialists believe domestic investors will continue to plough into Hynix, comforting those international investors who might otherwise be wary of buying a stock that has already had such a good run.
Secondly, they believe foreign investors will view the forthcoming GDR as their first real opportunity to start building sizeable positions in the company.
When Hynix last accessed the GDR market in June 2001 it was a very different story and the company was fighting for its survival. It had got into trouble after buying LG Semicon in 1999 and funding the purchase with short-term debt at a time when the industry was entering a severe downturn.
By 2001, it initially looked as if it might be able to dig itself out of the hole its had created for itself. It had disaffiliated itself from the Hyundai Chaebol, appointed independent managers and secured a Won5.6 trillion agreement from creditor banks (then worth about $4.3 billion).
However, this restructuring agreement was contingent on Hynix being able to complete a capital markets deal - the company's reluctant creditor banks wanted concrete proof that international investors believed it had a future before extending yet another financial lifeline.
In June 2001, Citigroup raised $1.25 billion for Hynix from the international equity markets after pricing a 104.165 million unit GDR at $12 each. By the end of the year, however, the GDR was trading below $1 per unit after DRAM prices failed to re-bound and Hynix was unable to generate enough cash to meet a new set of debt maturities.
This liquidity crunch forced it into a second debt restructuring and a take-over by its banks. Since then, Hynix has undergone what many describe as a quite miraculous recovery. And unlike much of corporate Korea, it has done so without the aid of a foreign strategic or private equity investor.
Over the past four years, it has sold assets, pared capex and benefited from an upturn in the industry. This in turn has not only enabled it to pare debt back to industry standard levels, but also leapfrog both Micron and Infineon in terms of market share.
Unable to keep up on the technological roadmap through huge capex spending, Hynix adopted a fab-lite strategy instead. This has seen it outsource chip production to a 12" fab owned by ProMOS and to establish a JV for a12" fab in China with STMicroelectronics.
Hynix is on course to have more 12" capacity than any of its rivals by the end of 2006. At the end of the second quarter of 2005, by contrast, 12" capacity only accounted for 12% of total capacity compared to a 35% industry average.
Analysts also highlight Hynix's quick adoption of NAND technology as a clear example of its renewed dynamism and desire to improve its product mix by moving into higher margins products.
NAND flash chips are fast replacing DRAM as the industry standard and Hynix has become the world's third largest manufacturer behind Samsung and Toshiba in the space of just over a year-and-a-half. Samsung predicts that NAND will overtake DRAM by 2007 as handsets replace PCs as the main driver of chip production.
DRAM chips are used in PCs to temporarily store data for fast access, while NAND chips are used in the memory cards of communication devices such as MP3 players and digital cameras. The main difference between the two is that DRAM chips do not need to retain data once the device is switched off, while NAND chips do.
But for longer-term investors, the key question concerns the industry cycle. Stock prices tend to closely mirror DRAM prices and currently the direction is up. Prices of the benchmark 256Mb DDR chip hit a low of roughly $2 in the second quarter and have since re-bounded to around $2.68.
DRAM manufacturers have guided that prices should see single digit growth to the end of 2005 and have been forecasting a price band of $2.7 to $3. However, some analysts caution that we may not be seeing the beginning of a new upcycle since DRAM prices tend to peak in the third quarter.
A number also worry what impact high oil prices and property bubbles are having on consumer spending patterns in developed economies. Tech stocks are currently not in vogue and some analysts believe they will stay that way unless consumer spending shows a strong uptick in the run up to Christmas.
