STX Pan Ocean achieves 25% premium on unhedgeable CB

STX Pan Ocean, Korea's largest bulk shipping company, last night raised $200 million from a five-year convertible bond that seems to have benefitted from expectations of a continued improvement in bulk shipping rates. According to a source, the deal was a bit more than 1.5 times covered at the final price and attracted about 70 investors.

With no stock borrow available, investors were not able to hedge the equity portion of the CB and as a result most of the demand came from fundamental investors -- many of whom were based in Europe. Their belief in the potential upside for the stock was evident by the fact that the company was able to fix the conversion premium at the mid-point of the offering range at 25% in spite of it having just reported a 92% drop in third quarter profits due to sector overcapacity and lower cargo rates than a year earlier.

However, the Baltic Dry Index, which is the benchmark indicator for commodity shipping rates, has staged a recovery over the past three months following a pretty disastrous 2008 and has been particularly strong in the past couple of weeks amid growing signs of a global economic recovery. This has led analysts to conclude that the industry has bottomed out and that shipping companies as a group will be able to capitalise on the renewed pickup in demand for commodities, including iron ore in China and coal in India.

"This is an interesting time to get into the cycle," said the source, who argued that a CB is a good instrument to choose for those investors who are not yet convinced that the outlook is all positive since they get an annual coupon and downside protection in the form of a bond floor. At the same time, investors will get exposure to the potential upside in the share price.

Some analysts are indeed arguing that the outlook is less straight forward for STX Pan Ocean. In a research report released last month, analysts at Citi say the market may have underestimated the scale of the company's funding problems and overestimated the magnitude of an earnings recovery from a rebound of the Baltic Dry Index.

"While fiscal 2010-2011 net gearing of 0.6 times is acceptable, our chief concern on financing is the availability of funding rather than the level of debt leverage. Bank borrowing remains a challenge considering the wide spreads and high value-to-loan ratios. Corporate bonds will mature in 2010-2012 and need to be refinanced," the report said.

Indeed, STX Pan Ocean's share price hasn't really captured the improvement in bulk rates in recent weeks, but has continued to range trade. The stock is listed both in Seoul and Singapore, with the most liquid trading in Korea where it has hovered between W10,500 and W12,500 a share since the beginning of September. And although the share price has rebounded from a low of below W8,000 in early March, it is up only 20% this year, compared with a 40% gain in the benchmark Kospi index.

In the sense that funding is a concern, the CB should relieve the pressure somewhat. The company said it will use half the proceeds to fund part of the acquisition cost for new-built vessels and the rest as working capital. STX Pan Ocean announced in September that it has signed a 25-year contract with Vale International worth approximately $5.84 billion to ship iron ore from Brazil to China. The shipments will start from the fourth quarter of 2011 and will require STX Pan Ocean to acquire eight new very large ore carriers at a total cost of $880 million, 30% of which needs to be paid in cash.

The CB, which was arranged by Goldman Sachs, can be put back to the company after three years, and there is the issuer call after three years, subject to a 130% hurdle. They were offered to investors with a conversion premium between 20% and 25% over yesterday's close of W11,300 and a coupon ranging from 3.75% to 5.00%. And while the conversion premium was fixed at the mid-point, the coupon was set in the investor-friendly half of the range at 4.5%. The bonds are issued and redeemed at par so the coupon is also equal to the yield. They can be converted into shares listed either in Korea or Singapore.

The credit spread was assumed at 600bp and investors will get full compensation for dividends paid both in cash and shares. The outcome was a bond floor of 91.4% and an implied volatility of 24%.