The unusual triple-A backed exchangeable was priced after London's close on Thursday towards the outer end of its indicative range. Led by Credit Suisse First Boston, the 2.2 year deal carries a coupon of 3% and an exchange premium of 16% to Kia Motor's W10,150 close.
With a par in par out structure, the transaction has a bond floor of 95.5% and fair value of 108%, based on implied volatility of 13%, zero yield and zero stock borrow. Historic volatility was assumed at 30% Gross proceeds for the 51 million share deal amount to $466.931 million.
Originally, the deal had been marketed on a coupon range of 1.75% to 3% and a conversion premium of 15% to 23%.
About 100 investors are said to have participated, with about 60% of paper placed in Europe, of which about 50% went to the UK. The remainder was split 25% US and 15% Asia. By investor type, it is reported that a balanced mix of funds participated including outright, hedge and fixed income accounts, with a smattering of equity.
Ranking second to KDIC/Kepco as the largest Korean equity-linked deal on record, Hyundai Motor's offering also stands out for its 3% yield-to-maturity, the lowest in the Korean market. This results from the collateralized structure of the deal, which matches every dollar of coupon liability with a dollar of Treasury Strips.
For a small number of market observers, it is a structure that makes little sense from the issuer's point of view. Critics put forward two major arguments.
The first concerns the lack of proceeds. For most borrowers, one of the main advantages of an exchangeable would be the chance to raise cheap debt as well as sell-off an unwanted equity stake. Yet in this instance, all proceeds are invested in the Treasury strips backing the deal. As one banker queries, "What's the point of paying capital markets fees when no capital is raised?"
Lead bankers have previously pointed out the underlying rationale in reference to a similarly structured deal for the Industrial Bank of Korea (IBK) into Korea Tobacco & Ginseng (KT&G) last December. In essence, they have argued that the structure suits those issuers with no immediate funding need. In Hyundai's case, the company was also particularly keen to avoid ballooning its balance sheet at a time when it is trying to reduce debt.
The second argument concerns cost of carry. One banker argues that with a coupon of 3% and an underlying treasury yield of about 4.3%, the borrower only receives a 1.3% differential and even less when the lead's fees are stripped out. However, as a second counter-argues, there is no negative cost of carry since the treasury yield is greater the coupon payment.
"Under the accounting treatment of a number of jurisdictions, the bond component has to be stripped out from the options payment anyway," says one observer. "For this deal, the borrower would definitely book positive income from the option payment.
"But the main point of an exchangeable is not raising cheap debt," he continues. "It's to allow an issuer to divest itself of shares in a cost effective manner. Most exchangeables have extremely short maturities, because the idea is to force conversion sooner rather than later. The sole objective of a structure like this would be to encourage conversion on the back of upside momentum in the underlying stock. Hyundai would, therefore, have looked for a structure that suited its expectations about the stock and desire for conversion."
Since the exchangeable represents 59% of Kia Motor's free float, it would have proved almost impossible for the company to divest itself of such a huge stake through a straight placement without causing massive disruption to the underlying stock. As it was, difficulties short -selling Korean market meant that the share price remained stable and hedge funds were forced to take a naked position.
Just prior to the launch of the deal on Tuesday, for example, Kia Motor closed at W10,800 and was down only slightly on pricing two days later at W10,150.
Compared to the IBK transaction that preceded it, Hyundai's offering differs in one key regard. Where IBK opted for a premium redemption structure based on positive expectations for KT&G's stock price, Hyundai Motor opted for a par redemption structure, which has greater appeal for investors because they receive a higher coupon. IBK, for example had a 1.5% coupon and 4.14% yield-to-maturity, while Hyundai has a 3% coupon and 3% yield.
One of the lead's main challenges would have been to convince investors about further upside on a stock, which many are not very familiar with, none can hedge and more importantly, has vastly outperformed the Kopsi year-to-date. Where the index is up roughly 25%, Kia is up about 50% and its parent Hyundai Motor an even more impressive 110%.
It would have been aided, however, by Moody's decision to upgrade Hyundai Motor from Ba3 to Ba2 yesterday (Thursday). In its ratings assessment the agency cited the company’s, "improving performance in the Korean and US automobile markets and the progress made in improving its financial leverage and liquidity."
From a technical standpoint, Asian convertible experts also conclude that the deal would have been attractive for outright accounts and fixed income investors looking for an equity kicker.
"A rock solid bond floor and a highly volatile stock are the perfect combination, even if the underlying shares are difficult to hedge," says one. "Highly volatile stocks do not normally have a strong credit standing, but in this case, the bond floor is razor sharp. No-one can argue about credit spread, because there isn't one."
Based on a pure credit pass-through structure, the transaction reduces Hyundai's 47.6% stake in the company to 34.5% assuming full conversion. It revolves around two SPV's, which create bankruptcy remote vehicles removing Hyundai's stand-alone credit from the picture.
The first SPV (HMC Cayman) issues an exchangeable to investors and invests the proceeds in US Treasury strips to meet all coupon and principal obligations on the notes. Additional proceeds are used by Hyundai Motor to obtain option premiums from the Cayman's SPV via the Korean SPV (HMC-KIA Securities Trust). In return for these option premiums, Hyundai Motor entrusts the Korean trust with its 51 million Kia Motor shares.
The Korean trust then issues a senior certificate (call option) back to the Cayman SPV and a junior certificate to Hyundai Motor. The call option allows noteholders to exchange their pro rata share of collateral for the relevant number of Kia Motor shares held by the Korean trust. As junior certificate holder, Hyundai Motor then receives cash, shares or a combination of the two depending on the ultimate level of conversion when the bond matures in August 2003.
