Sino-Ocean upsizes convertible deal to $900 million

Chinese real estate developer Sino-Ocean Land Holdings has exercised the entire upsize option on the perpetual subordinated convertible securities that it priced on Tuesday morning, increasing the deal size to $900 million. That makes it the largest equity-linked deal in Asia since CapitaLand sold S$1.3 billion ($920 million) of convertible bonds in February 2008.

At the same time, market participants continued to ponder who bought the bonds, which thanks to their perpetual and subordinated nature, lack of a step-up coupon and very low bond floor, were not viewed as particularly attractive to usual CB buyers such as hedge funds.

Sources said the majority of the deal had been placed with long-only type accounts, including some of the company's existing shareholders, before launch, leaving only a small portion of the deal available for the wider institutional investor community. Research analysts at one bank even said they had decided not to cover the issue since they had heard that at least $750 million went to "strategic" investors, implying there won't be much liquidity in the name. The liquidity issue was basically confirmed by the fact that only 20 or so investors participated in the $650 million base deal.

In the first two trading days after pricing there has also been virtually no trading in the securities, although some market participants said there were some bids at 100-101. The securities will be listed on the Singapore Exchange.

As suggested by the small number of investors -- implying an average order size of more than $30 million -- the interest among those who were offered to buy the bonds was strong. One source said the fact that the upsize option was only exercised after two days of trading, as opposed to immediately at pricing, was primarily due to technical issues, including a need for some investors to get their internal approvals in place.  

Hong Kong-listed Sino-Ocean launched the deal after the market closed on Monday and priced it early Tuesday (Hong Kong time). The initial deal size was $650 million with a $250 million upsize option and it came with fixed terms, including an 8% coupon -- or dividend distribution, as it is referred to on these types of securities -- and a 15.3% conversion premium that gives a conversion price of HK$6.85. Investors can convert the securities into equity, starting from 12 months after the July 27 closing date.

Being a perpetual, there is no investor put, but an issuer call after five years at 110% of face value. The issuer can also force conversion at any time after the first 12 months if the share price is averaging at least 82.5% above the conversion price for a 30-day period. That implies a share price of at least HK$12.50 -- a level that the stock hasn't traded at since the fourth quarter 2007 when it briefly went above HK$14.

Sino-Ocean listed in Hong Kong on September 29, 2007 after pricing its $1.5 billion initial public offering at HK$7.70 per share. Over the past 12 months the stock has reached a high of HK$8.77 (in late July 2009) and on Monday, before the launch of this deal, it closed at HK$5.94.

Observers say that the fact that the securities are callable at 110% and don't have a step-up coupon if they are not called -- as is otherwise common on perpetual issues -- means there is no real incentive for Sino-Ocean to call them. Especially since the main purpose of using this type of instrument is that the securities are treated as equity on the balance sheet from day one. From an accounting perspective, convertible bonds are treated as debt until conversion when they become equity.

The addition of this much equity also gives the company, which prior to this transaction had a fairly high net gearing ratio of about 63%, a lot of opportunity to issue more debt to finance its new and existing projects. In a statement issued to the Hong Kong stock exchange, Sino-Ocean said its directors are of the view that this deal "will facilitate the addition of the group's landbank and hence the overall development and expansion of the group".

The proceeds from the perpetual securities will be used for the same purposes, including construction and land costs, as well as for general corporate purposes.

While beneficial to the company, the deal could, however, result in a significant dilution for the existing shareholders, which may explain their interest in participating in the deal. However, neither of the company's two largest shareholders -- China Life Insurance and Cosco International -- bought any securities, according to sources. If converted in full, China Life's shareholding will drop to 20.4% from 24.1%, while Cosco's stake will fall to 14.3% from 16.8%.

The deal accounts for 18.11% of Sino-Ocean's existing share capital. Meanwhile, the value of the securities over a five-year period (chosen because the bonds become callable without any hurdles thereafter) can be calculated at about 30%, using the 8% annual dividend on the new securities minus the 2% annual dividend that is already paid on the existing shares times five. And since the securities can be converted into equity at a 15.3% premium over today's share price, investors essentially get the shares at a 15% discount to their five-year value, one source said, noting that this makes them look cheap compared with the existing equity.

Whether or not equity investors were actually looking at this, or simply reacting to the dilution, Sino-Ocean's share price fell 1.5% on Tuesday and another 3.4% yesterday to HK$5.65. And, given the announcement after the close yesterday that the deal has been upsized in full, it is reasonable to expect that it will take another hit today.

The deal was arranged by BOC International, J.P. Morgan and Macquarie Capital Securities.