Hon Hai Precision and Tata Engineering & Locomotive accessed the convertible market yesterday (Wednesday) raising a combined total of $500 million. Of the two deals, Tata offered the most rarity value as it is the first proper Indian CB since a $99 million issue for Gujarat Ambuja Cements in January 2001 and the first transaction without credit enhancement since 1997.
With Citigroup and Merrill Lynch as lead managers, Tata's deal was opened and closed within two hours, attracting an oversubscription level of 10 times even after orders were capped. The issue size was also capped at $100 million, since any amount above this level would require regulatory approval.
Raising proceeds of $90 million, with a $10 million shoe, the transaction was priced at the tight end of terms. This resulted in a coupon of 1%, conversion premium of 17.5% to a spot close of Rs213.4 and redemption at 116.824% to give a yield-to-maturity of 4.1%.
Indicative terms comprised a conversion premium of 12.5% to 17.5%, redemption price of 116.82% to 119.73% and yield of 4.10% to 4.6%. There is also a three-year call subject to a 125% hurdle, but no put option since Indian companies are unable to shorten the maturity below five years.
Underlying assumptions comprise a bond floor of 92.3%, theoretical value of about 106% and implied volatility of about 27%. This is based on a credit spread of 275bp over Libor, 4% stock borrow cost, 3% dividend yield and historic volatility of 28% to 30%.
A 4% stock borrow assumption derived from the fact there is said to be a little borrow available against the company's GDR. And while Tata is currently paying 1.8% yield, a 3% assumption was used because the company has started to increase the pay-out ratio and analysts believe it should settle at the higher level going forwards.
Observers say that only about 30% of demand came from asset swap accounts, with the rarity value of the deal acting as its main driver. A total of 135 investors are said to have participated, with a geographical breakdown, which saw 30% placed in Asia, 30% with offshore US and 40% into Asia.
For Tata, the deal is said to have been cost effective because even when 2% swap costs are factored into the all-in cost, the deal is still considerably cheaper than the equivalent 7% levels of the domestic market. And bankers believe that the deal may presage a spate of similar transactions from the subcontinent, with ICICI set to follow with a fixed rate bond via Deutsche and Merrill Lynch.
From an investor standpoint, the equity market also appears to have returned to favour. In a recent research report, UBS wrote, "The blocks to building a strong market are in place. We point to regulatory changes, increasing capex, outsourcing of services and manufacturing and the growing affluence of the population as sustainable drivers of the market."
A few hours before Tata, Hon Hai Precision also priced its first convertible since November 2000. Raising $400 million with the addition of a $50 million greenshoe, the deal appeared to be smoothly executed by lead manager ABN AMRO.
Many market players had been watching to see if the Dutch bank would trip itself up following its incredibly aggressive bid for one of Taiwan's most prestigious accounts. The deal was won just over a week ago on terms comprising a zero coupon, zero yield, 51% conversion premium. No-one else thought these levels achievable and indeed the company allowed terms to be changed so the deal could successfully clear the market.
In recent weeks bankers have become increasingly worried that pitches for Taiwanese convertible mandates are becoming so competitive that one deal is bound to go badly wrong, close the market and leave the lead manager in question with a lot of paper sitting on its books. However, because Hon Hai allowed market reality to hold sway, it seems likely to encourage even more ludicrous pitching to the annoyance of a company's house bank, in this case Goldman Sachs.
As one banker comments, " A house bank can't afford to compromise its reputation with a key client by submitting terms it knows it cannot execute. But for everyone else, putting in an outlandish pitch is regarded as a very attractive free option on future business."
ABN Amro is, nevertheless, likely to be extremely happy that it has not only been able to steal a march on the competition, but turn the mandate round quickly and successfully. The deal was priced with a zero coupon, negative yield structure on a conversion premium of 39% to a spot close of NT$150.
Using a five-day average, the deal has come at a 40.5% conversion premium, the highest on record for a Taiwanese deal.
With an issue price of 100.50%, the deal redeems at par and can be called after two years subject to a 130% hurdle and also put after two years at par. The yield-to-maturity comes in at minus 0.10%.
Underlying assumptions for the deal comprise a bond floor of roughly 95%, theoretical value of just under 102% and implied volatility of about 33%. This is based on a credit spread of 75bp over Libor, zero dividend, 4.5% stock borrow cost and 35% historical volatility.
Observers also note that while the company is rated BBB by Standard & Poor's, an implied single-A rating was used to value the CB, since Hon Hai has a much higher credit profile on a stand-alone basis. "The agency has acknowledged that if the sector hadn't blown up in the States a few years ago, this deal would have had a much higher rating on a pure fundamentals basis," says one.
Outside observers thought the deal relatively slow going as terms were aggressive and the deal had traded down in the grey market. Others were only prepared to say that the deal was "comfortably" covered, with a geographical split, which saw 60% placed into Europe, 25% in the US and 15% in Asia.
In terms of the high conversion premium, it seems likely the company was also able to achieve it because it has lagged the performance of the TWSE. Although it has outperformed the index by 10% over the past month, it still up a more modest 25% on the year compared to the 50% plus levels of other tech stocks.
And analysts believe that it is still undervalued because it has not fully consolidated better than expected handset sales into its revenue figures. UBS recently commented that while unconsolidated sales were 5.2% higher than consolidated in 2002, they may be as high as 10% this year, because Hon Hai has not consolidated its handset operations in China. The PC components manufacturer also recorded strong sales growth in June after two flat months. Sales rose 31% to NT$22.3 billion.
