Lead managers Deutsche Bank and Merrill Lynch successfully priced a Y52 billion ($440 million) exchangeable for Korean steel company Posco on Tuesday. The deal was something of an exercise in showmanship with Posco demonstrating its enduring appeal to international investors.
The deal sees Posco issue the five-year bonds, which are exchangeable into 15.5 million ADS of SK Telecom. The shares represent 2.5% of the total outstanding shares in SK Telecom and roughly one third of Posco's stake in the company. The bonds were priced at 100.5% thereby giving them effectively a negative yield, being repaid at par at maturity. They carry no coupon.
Most startling about the deal is that the company managed to secure a 52% conversion premium on the deal, the highest ever conversion premium for an exchangeable sold by an Asian issuer. Having gone out with an indicative range of 50%-55%, the deal priced in the sweet spot.
From the outset, when Posco mandated the leads two weeks ago, the company stressed that its main objective in the deal was maximizing the amount of money it could raise from this monetization exercise.
The leads aimed at pricing the deal at the close of New York business on Tuesday April 12th. However, it soon became apparent that hedge funds had got wind of the deal and were trading down the SK Telecom ADS in the grey market. This lead to a change in strategy whereby the leads undertook an accelerated book build to close the deal in London before New York opened for trading. To compensate for the acceleration, the company offered to include a three-year put option into the deal, which allowed them to maintain the relatively high conversion premium. By shortening the duration of the bonds, they maintained the headline valuation - although some analysts suggest that the inclusion of the put effectively reduces the overall value of the deal.
Other market observers have commented that the deal was unnecessarily complicated and that Posco's insistence on maintaining the conversion premium could have backfired. But in the end, the bold strategy appears to have worked. While the SK Telecom ADS traded down yesterday in New York, the bonds actually traded up to 101.5%, seemingly vindicating the aggressive strategy. As a result, at the close of play on Wednesday the bonds were trading with a 58% premium to the underlying stock.
Bankers close to the transaction comment that it was the combination of Posco's strong credit and SK Telecom's equity story that made the deal irresistible to investors. Indeed in the days leading up to the transaction, S&P upgraded Posco's credit rating from BBB+ to A-. This came on the back of stellar results, which saw Posco's second quarter profits almost triple.
SK Telecom also released strong results on Wednesday, revealing that its six month sales rose 14.5% and profits rose 10.5%. Indeed many analysts believe that the SK Telecom stock is undervalued and has been dragged down by the woes of parent company SK Corp. The general consensus is that if SK Telecom was spun off from its parent, its position as the leading mobile company in Korea would warrant a much higher valuation. Such sentiments clearly buoyed the Posco deal. Indeed when SK Telecom's parent last year launched a similar exchangeable into SK Telecom shares, it could only achieve a premium of 26%, although the deal was considerably larger than that undertaken by Posco.
A further challenge for the leads came in the decision to do the deal in yen. As the first ever samurai exchangeable by an Asian issuer, this was always going to be a challenge. Posco has a maturing yen loan and it wanted the proceeds to be able to hedge against that exposure. The company also wanted to take advantage of the low yen interest rates, which allowed the deal to be priced with a negative yield. In the end the unusual structure of this transaction affected the deal minimally.
