Champion Reit launches combined follow-on and CB

Champion Real Estate Investment Trust was in the market last night to raise $980 million from a follow-on equity placement and a concurrent convertible bond. The proceeds are to be used as part-payment for the HK$12.5 billion ($1.6 billion) acquisition of Langham Place that was announced more than three months ago.

The structuring of the CB has taken some time to complete as the issuer needed to ensure the deal was accepted by investors at a time when property stocks have been generally out of favour. It also needed to achieve a low-coupon structure to meet its main objective of the Langham Place acquisition being yield accretive. But more than anything, the issuer has been waiting for the right market window.

In terms of Champion’s unit price, yesterday may not have seemed like the most auspicious day to execute the deal – in fact the trust has fallen for five straight days and at yesterday’s close was only 4.3% above the 52-week low of HK$3.69 that it hit in mid-March. However, the overall market sentiment has definitely been picking up and the sale of a S$650 million ($478 million) CB for Singapore’s largest Reit, CapitaMall Trust, last week proved that investors can be persuaded to invest in this sector. The CapitaMall transaction attracted about 60 investors and was priced inside best-terms for investors. However, the share price has fallen 6.8% in the three days since the deal was completed, dragging the bonds below par. As of last night they were quoted at about 98.5/99.5.

At HK$4.68 billion ($600 million) Champion’s CB is the larger of the two legs, while the placement will total about $380 million. According to sources, the bookrunner was still waiting on some potential US investors late last night, which meant the combined deal wasn’t due to be priced until this morning.

The total financing package for Langham Place of HK$12.9 billion (including about HK$300 million of transaction costs) will also include a sale of new units to Champion’s sponsor, Great Eagle Holdings, and a bank loan. There was no word yesterday on how those portions would be split. Based on the approval granted by the unitholders in early March, Champion can issue HK$8.8 billion of new equity to Great Eagle and the public combined, while the loan can be up to HK$3.6 billion. One source familiar with the deal said the working assumption had always been that the placement and the share sale to Great Eagle would each account for around $400 million, while the CB would be about $600 million, leaving a smaller $200 million portion for the loan.

Citi is the sole arranger for the entire financing package and also acted as the financial adviser to Champion manager Eagle Asset Management on the Langham Place acquisition.

The CB was offered slightly below par in the grey market last night, but at the same time specialists say the terms looked reasonable from the investors’ point of view. One analyst referred to it as “slightly attractive on best indicated terms”. With regard to the placement, the discount is looking a bit tight at 1.3% to 6.5% versus yesterday’s close of HK$3.85, but considering that the unit price fell 3.3% yesterday and has lost 6.3% over the past five sessions, that too may be reasonable. It seems likely, though, that investors will try to push the discount towards the maximum.

“The key challenge is the size,” says one specialist, “and it is still unclear how much appetite there is for property-related deals.”

On size, there is no question that this is a large trade that could take some time for the market to absorb. The equity portion alone accounts for 27.7% to 29.3% of the existing share capital, depending on the final price, and more than 250 days worth of trading volume.

The acquisition of Langham Place, which includes a retail mall and an office tower, will be a transformational deal for Champion, however, which should increase its attractiveness to outright equity investors. The deal will see Hong Kong-listed Champion step up from being a single-asset Reit – its only asset at the moment is Citibank Plaza, a grade-A office building near Hong Kong’s prime Central area - to a more diverse vehicle in terms of location, tenant base and income streams. It will also increase its asset value by 52% to about $5.3 billion and make Champion Reit the third largest Reit in Asia outside Japan, measured by market capitalisation. The only two that will be larger are Hong Kong’s Link Reit and CapitaMall Trust in Singapore.

To help overcome the potential scepticism about the property sector, the Champion CB will be secured on the Langham Place property, using a structure that is similar to the one used by CapitaMall last week. In this case, however, the bondholders will share the security with the banks providing the loan – a novelty that is bound to have needed some explaining to investors.

The CB also includes a number of financial covenants and protection for the bondholders should Champion decide to sell part or all of Langham Place during the life of the bond.

The bonds have a five-year maturity with no put, but can be called by the issuer after three years, subject to a 130% hurdle. The coupon was fixed at 1% at launch, while the yield-to-maturity is offered at between 4.75% and 5.25% per annum. The conversion premium is offered at 25% to 32% and will be set over the final placement price.

Market participants say Citi was indicating a credit spread of 200bp over Libor, which is below the 250bp spread indicated for the CapitaMall transaction last week. Goldman Sachs, which was the sole bookrunner for the CapitaMall deal, offered credit protection at that level, but saw very few takers with some saying the spread was too wide. However, the fact that Champion is an unrated credit, while CapitaMall is rated A2 by Moody’s, and that this deal is two years longer than CapitaMall’s effective three-year maturity, suggests that investors may be reluctant to accept a spread as tight as 200bp, which is where CapitaMall is currently trading.

Based on a spread of 250bp and best terms for investors, the bond floor would end up at about 95.5%-96% and the implied volatility at around 23%. If the credit spread is pushed to 200bp, the bond floor will increase to about 98%.

The placement units were offered at a price between HK$3.60 and HK$3.80, which, according to the term sheet, will translate into a proforma 2008 dividend yield of 9.2% to 9.5%. The price range also represents a discount to net asset value of 39% to 41%. The number of new units to be issued will vary with the final price to result in a total deal size of about $380 million.

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