Soho China pulls off Asia's largest CB this year

Commercial property developer Soho China last night raised HK$2.8 billion ($360 million) from a convertible bond, which primarily tapped into fundamental demand for the stock, and a belief that the current recovery in the Chinese property sector is set to continue, rather than conventional demand for CBs.

The terms were fixed at the most generous end from an investor point of view, but the company still managed to achieve quite an attractive borrowing cost with an annual coupon at 3.75%. In fact, some investors were said to be unhappy with the coupon -- as the bonds will be redeemed at par there is no additional yield on top of the coupon and there are plenty of other high-yielding CBs by Chinese property developers for investors to choose from in the market, such as Greentown China, Hopson or Country Garden.

Some were arguing that the credit spread needed to be wider than the 750 basis points over Hibor that the bookrunners were assuming in their modelling. However, according to one source, Soho China's strong liquidity position and low gearing eventually won enough investors over and the final order book was almost two times covered and contained more than 70 accounts. The deal was arranged by Goldman Sachs, Morgan Stanley and UBS.

The buying interest was likely helped by the fact that the deal was accompanied by a stock borrowing arrangement, whereby a company wholly owned by Soho China's CEO, Zhang Xin, lent enough stock to the three bookrunners to cover 60% of the deal size. The bookrunners will pass on the short position to the CB holders to allow them to hedge the equity option on the deal.

Whether or not it is necessary to ensure there is sufficient stock borrowing to successfully complete a CB these days isn't clear, but given that there has been only three other publicly marketed equity-linked deals by Asian issuers so far this year, the company likely didn't want to take any chances. The Soho China CB is also the largest deal so far, surpassing SK Telecom's $300 million CB in March and Beijing Enterprises' $275 million offering in April, and also doesn't have the strong credit rating or government-backing enjoyed by the other two. As was the case for most of last year as well, the bookrunners offered no asset swaps, meaning it will be difficult for the bondholders to hedge the credit.

The Hong Kong dollar-denominated bonds have a five-year maturity, but can be put back to the company after three years at par. The conversion premium was offered in a range between 20% and 33% over yesterday's close of HK$4.90 and fixed at the bottom for an initial conversion price of HK$5.88. The share price has had a strong run since it hit a 2009 low of HK$2.33 in early March and yesterday's close is on par with where the stock was trading 12 months ago. The coupon was offered in a range between 2.75% and 3.75%.

The company can call the bonds after the first three years, subject to a 130% hurdle.

According to sources, the order book comprised a combination of Asian investors and outright European demand, including arbitrage funds, hedge funds and long-only accounts. The momentum was particularly strong in the European book.

Aside from the 750bp credit spread, the other inputs included adjustments for dividend payout yields above 2% and a stock borrow cost of 1%. This resulted in a bond floor of 85.7% and an implied volatility of 24.4%, which compares with a historic volatility of about 50%-60% for Chinese real estate companies in general, people familiar with the transaction said.

Soho China, which focuses on commercial developments in Beijing, is already very cash rich (it had $1.6 billion of cash at the end of December) and in March it signed a five-year contract with Bank of China that will give it access to Rmb20 billion of M&A loans. In other words, the company isn't exactly in dire need of the capital raised from the CB, but likely saw the opportunity to raise further low-cost funding towards its aggressive acquisition plans.

In an interview with FinanceAsia in March, CEO Zhang said that 2009 will be very much about acquisitions for Soho China. The company has identified a number of projects -- some completed and some half-built -- in the Beijing or Shanghai city centres and, if possible, would like to snap up all of them.

"We will buy a lot. We have at least 10 projects that all qualify in Beijing and Shanghai. I don't know how many of those we can close in the near future, but I think quite a few of them," Zhang said at the time. "Our strategy basically is -- in a bull market, keep very little leverage and sell as much as you can, and in a falling market, leverage up and buy as much as you can."

If the company was to buy all 10 projects, it would more than double its current inventory.