Nine Dragons buys back 57% of its bonds

Nine Dragons Paper has announced that more than half of its outstanding 7.875% senior bonds due 2013 were tendered by investors during the early part of a buyback offer that will remain open until March 9. It has also scrapped plans to reduce the offer price by 5 cents per dollar for bondholders that failed to tender their bonds before an early deadline on February 23, saying bondholders can now receive the full offer price of 53 cents on the dollar throughout the remaining tender period.

The acceptance level shows that investors are welcoming the opportunity to exit illiquid assets and cut their losses, even if it means taking quite a substantial haircut and even in cases where the offering, from the issuer's point of view, is quite opportunistic. This should be encouraging for numerous other companies out there which are finding it increasingly difficult to service their debt as the economic downturn take a toll on their operations, and bankers say they expect buybacks and debt restructurings to remain a theme throughout this year.

Already in the market are ProMOS Technologies and Asia Aluminum, which are asking their respective bond and note holders to give up significantly more of the principal value - 86.5% on some of the Asia Aluminum notes - on the grounds that the companies are unable to pay any more and may face bankruptcy if the offers don't go through. Early indications suggest that investors in Asia Aluminum are not particularly happy with this ultimatum, while there is some interest among ProMOS's convertible bond holders to accept its offer.

As of the early tender deadline, Nine Dragons' bondholders had offered to sell back bonds with a principal amount of $160.4 million, representing 57% of the $283.75 million that remained outstanding when the offer was launched on February 9. Based on the early offer price of 53 cents on the dollar, this will cost the company $85 million. The tender is being arranged by Merrill Lynch.

It is reasonable to assume that bondholders who intended to accept the offer did so before the early deadline, since per the original terms they would have received only 48 cents on the dollar if they left it until after this deadline. However, it is possible that some investors who originally planned to hold on to their bonds will change their mind and tender anyway now that they know that the acceptance rate was quite high. With only $123.3 million worth of Nine Dragons bonds left outstanding now, the paper is bound to be illiquid.

The China-based manufacturer of paper and linerboard for packaging products didn't comment on why it had decided to extend the 53-cent offer for the remaining tender period, but a source noted that the company has the ability to retire all the bonds at this price and obviously wants to reduce its liability as much as possible. By offering the same price throughout the tender period, perhaps it can convince another few investors to go ahead and sell back their bonds.

"The acceptance rate is probably not going to increase that much, but basically there is no downside to extending the offer," the source says.

The company is keen to reduce its debt levels after a downgrade of its corporate rating by Standard & Poor's in December to BB- from BBB- (pushing the paper manufacturer into high-yield territory after being viewed as a low investment grade company when the bonds were launched) triggered an increase in the coupon payments on the bonds from 7.875% to 9.875% from the next interest payment date in late April. And last week, Fitch Ratings downgraded the company's foreign currency rating to B from BB- and the rating on the 2013 bonds specifically to CCC from B+, citing weaker operating performance, tighter interest coverage and high financial leverage. The ratings were also put on watch for a potential further downgrade.

Since it issued the bonds in April last year, Nine Dragons has slowed its pace of expansion as a result of the financial crisis, which means it has the cash to buy back all its bonds at the higher price. The reason why the company had a split offer price to begin with was obviously to encourage the bondholders to tender early.

Over in Taiwan, ProMOS is adopting a similar strategy of rewarding investors who act early on an offer to buy back $335.615 million worth of convertible bonds that opened last Friday -- albeit at a much lower absolute level. The cash-strapped memory chip maker is offering 20 cents on the dollar for investors who tender their CBs before 2pm London time on Monday (March 2), while bondholders who tender after that date will receive only 10 cents. ProMOS is also promising a tender success premium of up to 6.5 cents which will be paid if an acceptance rate of at least 86% is achieved. If the acceptance rate is between 82% and 86%, the success premium will be 3 cents per dollar.

ProMOS needs an acceptance level of at least 79% for the tender to go ahead, as this is one of the conditions attached to a NT$3 billion ($83.8 million) syndicated loan that it has arranged with a group of domestic banks in order to pay for it. This may be tough to achieve since the company is asking the CB holders to take an 80% haircut, and yesterday Bloomberg quoted a company statement filed to the Taiwan Stock Exchange in Chinese, saying the tender had not yet reached a successful acceptance level. According to the report, the company also called upon bondholders to seriously consider the ongoing tender, which the company views as the best option for them to recover at least some of their investment.

Having failed to meet a scheduled principal repayment of NT$830 million on a term loan from 2005 in December as well as a put obligation on the CBs, ProMOS is technically already in default, which means that any of its creditors can force it into bankruptcy at any time. If that was to happen, there are no guarantees that the CB holders would be able to get even 20 cents on the dollar back. The company has filed an application (still pending) with the Taiwan government for a 12-month exemption from the repayment requirements on the term loan.

Although yesterday's statement by ProMOS appeared to add a sense of urgency to the situation, sources familiar with the offering structure say the fact that the principal amount of CBs tendered hadn't reached 79% after the first three days is no indication of the potential interest for the offer. Most of the CB holders were intent on putting the bonds back to the company as of February 14 when the put option kicked in, and had thus submitted a put notice by the February 2 deadline. In order to now accept the tender offer - which replaces the put that ProMOS is unable to honour due to a lack of cash - they must first remove this notice, which will typically take a few days. The company has earlier said that 97.4% of the CB was put back.

In light of ProMOS's precarious situation, it seems likely that the CB holders will cut their losses and accept the tender offer, rather than hold out for a potential future recovery, or force the company into bankruptcy -- in which case they may end up with less. The DRAM chip maker, which recorded a 36% decline in its sales volumes last year as the global economic downturn led to falling demand for computers is bleeding cash, posted an operating loss of NT$24.5 billion ($705 million) in 2008 and had a cash balance of only NT$200 million at the end of January (excluding cash tied up as security for loans). In addition to its put obligations on the CB and the NT$830 million repayment that was due in December, ProMOS also has another NT$19.2 billion ($555 million) of principal payments on its debts coming due in 2009, indicating that a more severe debt restructuring will be needed.

The ProMOS CB is held by close to 70 accounts, of which about 60% are based offshore. The tender is being arranged by Citi.

Returning to Nine Dragons, Morgan Stanley argues in a research report last week that while the tender has bought the company some time to avoid the financial risk, its balance sheet concerns remain. These include a gearing of more than 90% (after the tender) for fiscal 2009, which ends in June, and the possibility that certain loan covenants will be breached when relaxations expire in fiscal 2010.

"The company needs to reduce its gearing further, preferably through improved operating means instead of financial engineering, before confidence is restored," analysts Charles Spencer and Mean Phil Chong said in the report.

Fitch argues that an improved operational performance in the second half of fiscal 2009 is "critical" to ensure that Nine Dragons maintains its credit metrics within the financial covenants that were re-set by its lenders at the end of 2008. "Any further deterioration could raise concerns over a potential breach of those covenants and lead to a potential acceleration of the debt by lenders," it said.

The lower rating on the bonds, meanwhile, was prompted by Fitch's view that the structural subordination of the notes has become significant and will become even more so after the completion of the tender offer, as Nine Dragons will have to obtain any necessary financing from onshore sources.

"The buyback transaction is viewed by Fitch as being opportunistic in nature, and while it stops short of conforming to the agency's definition of a Distressed Debt Exchange -- which would have resulted in a 'D' rating -- it would clearly result in an economic loss for any investors that had bought the notes in the primary market," it said.