Lotte Shopping raises $900 million from dual-currency CB

Korea’s Lotte Shopping last Wednesday raised about $900 million from the first dual-currency convertible bond in Asia ex-Japan in almost five years. The deal received strong interest despite a negative to flat yield and the continued volatility in financial markets and while the share price fell 7.2% yesterday, the CB held up quite well with one of the tranches trading above par and the other slightly below.

The deal was denominated in US dollars and Japanese yen and was initially launched at a combined size of $700 million — a $500 million dollar tranche and a ¥16 billion (approximately $200 million) yen tranche — but with an upsize option of $300 million that could be divided between the two tranches.

The demand turned out to be fairly even between the two tranches, but given the smaller size of the yen portion to begin with, it ended up being more than four times covered. That prompted joint bookrunners Goldman Sachs and Nomura to use most of the upsize option to increase the yen tranche to ¥32.5 billion ($403 million). The dollar tranche was kept at $500 million, resulting in a total deal size of $900 million.

That makes it the largest CB in Asia ex-Japan this year, ahead of Wharf Holding’s $800 million Hong Kong-dollar denominated offering in mid-May. It is also the largest CB in the consumer retail sector in the region ever and the largest Korean CB since Korea Electric Power Corp (Kepco) raised $1.03 billion in November 2006. The Kepco CB was also a dual-currency offering, although in yen and euros.

The interest in the deal was partly due to the strong credit. Lotte is rated A- by S&P and A3 by Moody’s, and is the only rated retail name in the Asian CB universe. The company is also significantly larger than the other retail names that have issued CBs recently, including Chinese department store operators Maoye and Intime, Chinese home electronics retailer Gome and Hong Kong-based watch retailer Hengdeli.

Lotte Shopping is the market leader in both department stores and supermarkets in Korea, and the country’s third largest operator of convenience stores and hypermarkets.

Both tranches have a five-year maturity with a three-year put and an issuer call after three years, subject to a 130% hurdle. Both also come with a zero coupon and were offered with a relatively moderate conversion premium between 23.8% and 28.6% over Wednesday’s close of W525,000 to help achieve the desired zero-cost structure.

The dollar tranche was marketed with a yield-to-maturity ranging from a negative 0.5% to 0%, while the yen tranche offered a yield ranging from a negative 0.75% to a negative 0.25%. The difference between them is a reflection of the fact that the three-year yen swap rate is currently trading at about 0.4%, while the dollar rate is close to 1%.

Most investors were said to have been focused on the fundamental equity story — 34 out of 37 analysts have a “buy” rating on the stock — and because the conversion premium was relatively low compared to most other Asian CBs this year, they didn’t worry too much about the negative yield.

That said, the bookrunners chose not to push the price, but to focus on upsizing the deal instead and all the terms were fixed at the investor friendly end. This resulted in a 0% yield on the dollar tranche and a negative 0.25% yield on the yen tranche. The latter will be achieved by redeeming the yen tranche below par. Both tranches were issued at par.

The premium was fixed at 23.8% for a conversion price of W650,000. Lotte reached a record high of W532,000 on Monday this week, and analysts have a 12-month target price of about W595,000 on the stock.

More than 100 investors participated in the deal, some in big sizes, and one source said there was at least 70% overlap in demand between the two tranches as most investors chose to put in orders for both. The split between hedge funds and outright investors was about 50-50, which is somewhat surprising. With the negative yield on the yen tranche, one may have assumed that there would be less outright demand for that.

The yen tranche was also slightly more attractive from an implied volatility perspective (which is something that is mostly watched by hedge funds) as it was priced at 24.2% compared with a 26.5% implied vol for the dollar tranche. One reason for that was to compensate for the negative yield and the fact that most investors are funded in dollars. The implied vol includes an assumption of a 5% stock slippage.

The deal was marketed at a credit spread of 175bp, which was based on the fact that Lotte’s outstanding five-year dollar bond is currently yielding about 180bp above mid-swaps. The $400 million bond was issued in early April this year. The bookrunners didn’t provide any asset swaps in connection with the sale, but there was an expectation that there would be swaps available in the market and that appears to have panned out yesterday.

The stock borrow cost was averaged out at 150bp, based on a 40bp to 50bp borrow cost off shore and a 250bp cost onshore after the launch of the CB, and the bondholders will be compensated for dividends exceeding a yield of 0.5%. This resulted in a bond floor of 92% for the dollar tranche and 92.4% for the yen tranche.

While funding in yen is slightly cheaper than funding in dollars, observers say the reason CB issuers turn to the Japanese currency is still mostly driven by the use of proceeds, which explains why yen-denominated CBs are quite rare in Asia. Lotte does indeed have about ¥11 billion ($136 million) of yen-denominated debt, as well as another $400 million of dollar-denominated obligations coming due this year. According to the term sheet, the company will use the money raised to repay foreign currency debt maturing in 2011 and to finance overseas investments.

The bookrunners chose to launch the deal after a rebound in US stocks on Tuesday gave a more positive tone to Asian markets on Wednesday. Buyers also returned to the CB market, suggesting there was a small window of opportunity to get a deal done. The offering was launched after the Korean market closed and kept open for about four hours to 9pm. Shortly after that, disappointing US data led to a reverse in sentiment again, and the Dow Jones index fell 1.5% over night, resulting in renewed selling pressure in Asia yesterday.

Korea’s Kospi index dropped 1.9%, which means that when taking into account the 5% stock slippage that was worked into the CB pricing, the 7.2% decline in Lotte’s share price was largely in line with the overall market. This explains why there wasn’t more selling pressure on the CB.

By the end of yesterday’s trading session, the dollar tranche was quoted at 98.875 to 99.125, according to a banker, while the yen tranche was quoted at par to 100.25.