Representing the sale of a 20% government stake, the deal also marks the first instance of a combined convertible and equity monetization out of Asia. In doing so, it follows recent precedent in Europe where France Telecom monetized a stake in cellular operator Orange and BP sold a stake in LUKOIL. In Asia, the only time that a convertible and DR have been launched simultaneously was in October last year, when China Mobile raised $7.2 billion in new money to purchase seven domestic networks.
The unusual structure of the KT&G's deal sees convertible proceeds being used to purchase a percentage of the government divestment, with the remainder of the stake being issued in DR format. Observers say that this structure was chosen over a straight exchangeable issued on behalf of the Korean government because of the strength of KT&G's credit.
In its credit report, Moody's highlights that the company's financial profile is constrained by Korea's Baa2/BBB sovereign ceiling. At the parent level, for example, the company has no debt and as of Financial Year Ended December 2000 enjoyed a net cash position of $620 million. Korean spreads have also been among the star performers in Asia so far this year, with a very strong domestic bid emanating from banks with excess Won liquidity and assets managers looking for yield pick up over domestic comparables.
To maximize credit interest in the rarity value of the KT&G name and avoid cannibalizing demand for the DR, the convertible has been structured to appeal to fixed income accounts and has a high bond floor and little equity optionality. With a five-year premium redemption structure, it will have a relatively long three-year put and no re-sets.
The coupon is being marketed at 2% to 2.5%, alongside a conversion premium of 13% to 18% and a three-year put at 125bp to 175bp over Treasuries, equating to a yield of 5.25% to 5.75%. The deal also features hard no call for two years, thereafter subject to a 130% hurdle.
Based on a credit spread assumption of 150bp over Libor, the bond floor comes out at a roughly 97% level and theoretical value at just over par based on 4% stock borrow and volatility of 35%.
At these levels, KT&G is being pitched in line with the Korea Development Bank (KDB), which is said to be trading on a bid/offer spread of 140bp/150bp over Libor in the credit default market. The state-owned bank also has a three-year outstanding maturity in the straight bond markets bid at about 167bp over Treasuries, or about 90bp over Libor.
Some observers add that news of indicative terms has prompted a number of asset swap bids below the 150bp level, with KT&G spreads tightening towards European BBB-rated comparables such as Vivendi Universal, which has a March 2004 issue outstanding at a current bid/offer spread of 115bp/125bp over Euribor.
In Asia, analysts say that the nearest comparable would be Baa2/BBB-rated KDIC’s $1.002 billion exchangeable into Kepco. Launched in September 2000, this also incorporated a five-year deal with a three year put and a credit spread assumption of 150bp over Libor. Traders say that paper is currently being bid at about 190bp over in the asset swap market.
Because Kepco shares have fallen heavily in the interim period, however, the deal is trading deeply out-of-the-money and currently has a conversion premium of 67.4% and yield-to-maturity of 5.15%. Trading at a bid/offer spread of 109.7%/110%, it also commands a high bond floor of 105.86%.
Where the GDR portion of KT&G’s deal is concerned, bankers say that should the overall deal be split 50/50, about 19.09 million shares will be offered to investors. The Korean government and its affiliates presently own a 77% stake, of which the Industrial Bank of Korea holds 35.37%, the Korean government 13.83%, the Export Import Bank of Korea 7.03%, KDB 6.9% and a couple of investment trusts the remainder.
The equity portion of the deal is being pitched as a defensive play for bear markets. As such Seoul-based bankers believe that it will be well received. “There aren’t that many large non TMT Korean companies for international funds to buy,” says the head of investment banking at one US investment bank. “This is a very defensive stock, with excellent EBITDA earnings and a very high dividend policy. I think it will fly.”
One of the key issues for investors will be the company’s ability to withstand competition as the Korean tobacco market is opened up to foreign brands. After a couple of years during the Asian financial crisis when the company’s market share leapt back up to the 95% level, it is back to historic level of about 85%.”
Analysts believe that high entry barriers to foreign brands hoping to establish distribution channels in Korea, means that the company will be able to continue enjoying significant market share over the medium term.
Moody’s credit analyst Tomomichi Nagaoka comments, “Even with competitors such as BAT establishing production facilities in Korea, their output when combined with foreign brand imports will amount to less than 10% of the overall domestic market.”
He also points out that the company has been successful in raising operating margins to 25% and plans to increase profitability further through increased efficiency. He says, “KT&G currently has seven manufacturing plants and four leaf tobacco processing plants. By 2003, it intends to have maintained the same output after closing two of the manufacturing plants and two of the processing plants. At the same time, officials told us that over the same period, the ratio of number of cigarettes per employee per hour should increase from 22,300 to 26,400.”
KT&G closed Wednesday at W16,900, down 11.05% year-to-date. It has a current yield of 8.28%.
