DHC Software, a Shenzhen-listed provider of customised enterprise systems and application software for corporate clients, has raised Rmb1 billion ($162 million) from the sale of a six-year A-share convertible bond.
The deal attracted orders from more than 1,000 investors, according to a source, reflecting the strong demand for good quality A-share paper. This bodes well for other CB issuers in the pipeline, including Sinopec, which has already secured the necessary regulatory approvals and is waiting for the right market window.
Little known outside the domestic market, DHC Software has been one of the best performing mainland-listed stocks this year. Just before the CB terms were announced on Wednesday morning last week, the share price had closed at an all-time high of Rmb23.95 on Tuesday, which left it up 70% since the start of this year. It then shot up another 10% last Thursday as investors scrambled to get their hands on the stock so as to be eligible to participate in the preferential offering of the CB.
Preferential offerings are a common feature of A-share CBs and essentially mean that existing shareholders get allocations before any other investors. In this case, the entire deal was available to DHC Software’s current shareholders, including those who had bought the stock on the day of the announcement. They were able to subscribe to CBs with a face value of Rmb1.443 for every one share owned.
The source said the take-up among this group had been very strong, and estimated that 80% to 90% of the deal would end up with existing shareholders, leaving very few bonds for other investors. The deal nevertheless attracted all the large domestic equity funds and insurance as well as a number of corporate accounts.
The attractive terms played a role, of course. Mainland CBs tend to come with low conversion premiums — typically no more than 5% versus the latest market price — as most issuers fix the conversion price at the regulatory floor, which is either the 20-day volume-weighted average price (VWAP) or at the VWAP the day before the announcement of the terms, whichever is higher. DHC Software offered a conversion price of Rmb23.70, which represented a 0% discount to last Tuesday’s VWAP and a 0.9% discount to the latest close.
And after the jump in the share price last Wednesday, and smaller gains on Thursday and Friday, the bonds actually came with a conversion discount of 13% versus the latest market price. However, investors cannot convert the bonds in the first six months, so a lot can change before then. The deal was open for subscriptions last Friday.
In addition to the low premiums, investors like convertible bonds because of the coupons and the downside protection. Issuers are aware of this, and tend to offer quite generous coupons towards the end of the life of the CB and even a back-ended yield. Because many CBs tend to convert into equity in the first two or three years, however, issuers like to keep the coupon payments low in the early years, hence lowering the actual cost of the funding.
DHC Software will pay an annual coupon of 0.5% in year one, 0.8% in year two, 1.1% in year three, 1.5% in years four and five and 2% in the final year. The bonds will also redeem at 105% of face value, offering an additional yield if held to maturity.
To trigger conversion if the share price is performing well, the issuer can call the bonds at any time after the first six months, subject to a 130% hurdle.
Meanwhile, investors can put the CBs back to the issuer at par in the last two years, but only if the share price is trading below 70% of the conversion price.
The deal also comes with a conversion price reset, which can be triggered if the share price is trading below 85% of the conversion price for 10 out of 20 days. However, the company would have to seek shareholders’ approval at an extraordinary general meeting before resetting the conversion price.
The company previously had a mandate to do a private share placement, but after difficulty getting this off the ground changed tack and opted to issue a CB instead. The latter is more flexible in terms of pricing, and benefits from a pent-up demand for convertible bonds given that the regulators are pretty restrictive with their approvals.
This was the first A-share CB since China Minsheng Banking Corp’s Rmb20 billion ($3.2 billion) issue in March. That deal also attracted huge demand, with the total order amount said to have exceeded $200 billion. It came with a conversion premium of 5% versus the latest close before the terms were announced. Haitong Securities and UBS were the arrangers.
After a long wait, China Petroleum & Chemical Corp (Sinopec) earlier this month received approval from the mainland regulators to issue up to Rmb30 billion ($4.8 billion) of A-share convertible bonds. However, it didn’t grab the initial window to sell the bonds ahead of its first-half earnings and sources say the next window will now be in September.
The company, which is listed both in Shanghai and Hong Kong, is known to be very price-sensitive though, and with the share price having fallen 22.5% since mid-June and 34% since its 2013 peak in March, the oil refiner may not be super-keen to bring the CBs to market right now. The approval is valid for six months. Goldman Sachs Gao Hua is the sponsor of the offering and a joint bookrunner together with Credit Suisse Founder Securities, CICC, Citic Securities, and Deutsche Bank’s Chinese joint venture Zhong De Securities.
Meanwhile, Ping An Insurance (Group) is still waiting for approval for its proposed A-share CB, which may raise up to Rmb26 billion ($4.2 billion). Here the CBs will be treated as equity even before conversion — a possibility sometimes open to insurance companies, depending on the interpretation of the local regulators.
When it announced the plans for the deal in December last year, Ping An said the CB would help boost its solvency margin ratio, which has come under pressure as its various business segments are experiencing rapid growth. It also noted that it needs to increase its risk buffers as the domestic Chinese economy faces slower growth and an increased risk of policy shifts as economic uncertainties persist.
Observers say that Ping An won’t get the go-ahead from the regulators until Sinopec has issued its CB, however, as they will likely want to see how well the market is able to absorb that deal before approving yet another multi-billion dollar transaction. CICC, Credit Suisse Founder Securities and Goldman Sachs Gao Hua are joint bookrunners for the Ping An deal as well.
Goldman Sachs Gao Hua was also a joint bookrunner for the DHC Software deal together with Huatai Securities. DHC Software’s share price fell 5.1% to Rmb25.85 yesterday, but remains well above the conversion price. The CB won’t be listed and eligible for trading until mid-August.
