Pakistan Mobile bond tender triggers default alert

As investors are pondering whether to accept a discounted bond tender offer from Pakistan Mobile Communications, Standard & Poor's yesterday issued a note saying that if the proposed transaction is completed, it "would view it as being tantamount to default". One reason, it says, is that the offer represents a "material" discount to face value.

The ratings agency also believes that the mobile operator could face difficulty servicing its debt obligations and complying with its covenants over the next one to two years, and has consequently downgraded the company's long-term corporate credit rating -- and that of this particular bond -- to CC with a negative outlook from B-. (The bonds are rated B3 by Moody's Investors Service, which is in line with S&P's previous B- rating.) Specifically, S&P believes the mobile operator may have trouble meeting a bank loan covenant to have a net borrowing to annualised Ebitda ratio of no more than 2.5 times by the end of June, down from a covenant requirement of three times by the end of December 2008. At the end of last year, the ratio stood at 2.8 times.

The comments from S&P may make the bondholders take another look at whether the discount on offer is in fact reasonable in the current market environment, but on the other hand, its suggestions that a potential default may be looming around the corner could also make them more inclined to cut their losses and cash out while they have the chance.

Pakistan Mobile, which is wholly-owned by Egypt's Orascom Telecom Holding and provides mobile services under the Mobilink brand, launched a tender last week to buy back up to $100 million of its $250 million 8.625% subordinated, senior, unsecured bonds due 2013. Bondholders who wish to participate can tender bonds at a price between 70 and 77 cents on the dollar. This price includes an early tender premium of 3 cents which the bondholders will receive if they put in a bid before the early deadline on Tuesday next week (5pm New York time). Bondholders who submit a bid after that will receive 3 cents less. The offer ends on May 6 and will be funded through an equity infusion from the parent company.

The tender is arranged by Citi and Deutsche Bank and conducted through a so called modified Dutch auction. This means the company will fix the tender price at the lowest level that allows it to buy back the entire $100 million. If the amount of bonds tendered exceeds the $100 million cap, the company will buy back bonds tendered at the final clearing price on a pro rata basis, while all bonds tendered at lower prices will be bought back in full. However, the company also reserves the right to sell less than $100 million worth of bonds at a price below the maximum price, meaning bids towards the upper end of the range may end up being unsuccessful at the discretion of the company. Similarly, if it receives good demand by the early tender deadline, it may also set the clearing price then and conduct the rest of the tender on a fixed-price basis.

While the minimum tender price represents a discount of 30% compared to face value, it is at a significant premium to the where the bonds were trading before the launch of the tender last week. At that time, the bonds were quoted at a bid-offer spread of 52-56, but they have been even lower. Between mid-September last year and early March this year, they were consistently bid below 45 cents on the dollar, so for many bondholders -- especially those with larger positions above $5 million or so -- the tender may provide a welcome chance to reduce their losses at a more reasonable price. Following the announcement of the tender, the market price spiked up to about 68-71 and market participants say there have been some trades at those levels in recent days.

A press release issued by Orascom notes that the purpose of the tender is to "reduce the company's overall indebtedness and future interest expense and to improve its financial position". It also notes that Pakistan Mobile believes that the offer provides an opportunity for the bondholders to gain liquidity in the notes that might not otherwise be available.

People close to the deal stress that this is not a distressed tender, but rather a prudent move by the company in response to the fact that its operating margins are under pressure.

However, S&P credit analyst Yasmin Wirjawan says that "if the proposed transaction is completed, we will lower the issue rating on the notes to "D" and the corporate rating to "SD" (selective default). Thereafter, we will reassess Mobilink's financial and liquidity position and its actual and projected operating performances before assigning new ratings".

The ratings agency notes that the company's credit profile has deteriorated over the past 18 months as it has undertaken significant debt-funded capital expenditures. At the same time, its competitive position and operating performance have weakened.