Sterlite prices five-year CB with 37.5% conversion premium

India's largest non-ferrous metals and mining company Sterlite Industries raised $500 million early on Friday from a convertible bond that featured the highest conversion premium on an Asian CB this year at 37.5%.

The offering, which was led by Deutsche Bank and Morgan Stanley, was structured like an Indian CB with a five-year maturity and no put, but since the bonds are convertible into Sterlite's American depositary shares (ADS) listed in the US, it was marketed like a US deal. This means the stock was trading during parts of the marketing and, as a result, the premium was fixed on the back of a share price that fell 10.5% during Thursday's US session. However, given that US investors are not used to CBs with no puts, the high premium was still an achievement and a testament to the faith investors have in Sterlite's equity story.

Indeed, a source noted that the success of the deal hinged partly upon investors taking a view on the fundamental story of the company. As a low-cost producer of metals like aluminium, copper, zinc and lead, Sterlite has an advantage against peers in more developed countries and acts almost like a leveraged play of the recovery in the commodities markets.

Early outright demand from Europe helped drive momentum in the book and the deal was also kept open in the early Asian morning on Friday to capture some interest from here, but as usual for deals linked to US-listed shares, the majority of the demand came from the US. According to the source, the order book was multiple times covered and included a lot of hedge fund demand, but the majority of the allocations went to outright investors. The book included well over 50 investors.

The CB was announced at about 12.40pm New York time on Thursday (or 00.40am Hong Kong time Friday), which meant it was marketed against a live US market for a bit more than three hours, although people involved in the deal said Asian investors had gotten a sneak peak for a few hours before that. In anticipation of a falling share price -- if possible, CB investors will typically go short of the shares to create a hedge for the equity option of the bonds -- the conversion premium was offered in a range between 30% and 40% over Thursday's volume-weighted average price (rather than over the close), while the coupon was offered at between 3.5% and 4%. The bonds are both issued and redeemed at par, meaning the coupon is also equal to the yield.

The coupon was fixed at best price for investors at 4%, but the premium was set towards the top end of the range at 37.5%, which resulted in a conversion price of $23.33 -- a level the stock last reached in January 2008. However, the share price has staged a strong recovery this year, gaining more than 300% from a low of $4.27 in early March and the investor appetite for the CB suggests a belief that it will continue to rise. Because the share price fell sharply after the CB was announced and continued to fall into the close, the VWAP, at $16.967, was 2% higher than Thursday's closing price of $16.62 and, as a result, the effective conversion premium was an even higher 40.4%.

This is well above that of the two Indian CBs the previous week for Larsen & Toubro and Tata Motors, which were both sold together with an equity follow-on and priced generously in order to convince investors to also buy the less attractively priced shares. L&T, India's largest engineering and construction company, featured a conversion premium of just 15%, while Tata Motors settled for half of that at 7.5%. Another bond that was eyed as a comparison was iron ore mining company Sesa Goa, which, like Sterlite, is controlled by London-listed Vedanta Group. Sesa Goa re-opened the Indian CB market on September 24 after an 18-month issuance drought with a deal that was priced with a 5% coupon and a 28% premium -- both set at best terms for investors.

Market talk suggested that the Sesa Goa deal may not have been fully placed in the market at issue and the price immediately fell below par. However, a share price rally since then has had a positive impact on the CB, which at the time of the Sterlite deal was quoted at about 112. That rally sparked hopes that Sterlite could see a similar move and, according to sources, may have helped attract additional investors into the deal.

On Friday, the Sterlite CB held just above par at 100.75-100.875. In the wake of the 10.5% drop of the US-listed shares overnight, the price of the company's India-listed common shares held up relatively well, dropping only 5.6%. And when the US market opened later that day, Sterlite's share price rebounded 7.2% to $17.82 -- leaving it only 4% below Wednesday's 16-month high of $18.57.

The bonds were marketed with a credit assumption of about 600bp over Libor and the final price terms resulted in a bond floor or about 81%. The latter is high for a US deal where investors typically are able to hedge the equity option and thus tend to buy CBs primarily on the back of their valuation metrics. According to market participants, there were about $250 million worth of Sterlite shares available to borrow for investors who wanted to go short the stock, which would have been enough to cover the delta of the CB for the investors who wished to hedge. The implied volatility was approaching 35%.

One source noted that Sterlite's bond floor and implied vol were both more attractive than a CB issued by Vedanta in June. Compared with its parent company, outright investors also favour Sterlite because it is closer to the operating assets. However, the marketing was helped by the fact that investors (European ones in particular) were already familiar with Vedanta, which is listed in London and has a couple of CBs outstanding.

Sterlite said it will use the net proceeds from the offering partly to expand its copper business with an allied power plant. In a separate announcement Thursday, the company said it will set up a brownfield copper smelter expansion project at Tuticorin in India that will have a production capacity of 400,000 tonnes per annum. The project will have an associated 160MW captive power plant and is expected to be commissioned by mid-2011.

After this expansion, which will require a total investment of about Rs23 billion ($500 million), Sterlite will be one of the largest single location custom copper smelters in the world with a total annual smelting capacity of 800,000 tonnes. According to the announcement, the project will be funded through a mix of debt and internal resources.

The CB proceeds may also go towards the acquisition of complementary businesses outside of India and other purposes allowed under Indian regulations, it said.

This was Sterlite's second foray into the equity capital markets this year. In mid-July it raised $1.5 billion from a follow-on sale of new ADSs to partly pay for the development of a commercial power generation business. One-third of that deal, which was arranged by J.P. Morgan and Morgan Stanley and accounted for 17.4% of the issued share capital, was bought directly by Vedanta. Sterlite is in the process of building a 2,400MW thermal coal-based power facility in the State of Orissa, which is scheduled to start commercial production this quarter and be fully completed by the second quarter of fiscal 2011 (which runs from April 2010 to March 2011).