UMC sells exchangeables with negative yield

Taiwan semiconductor company United Microelectronics Corporation (UMC) created a stir in the markets yesterday with two zero-coupon exchangeable bonds that were both offered at a negative yield. According to bankers, such a feature, while used previously by issuers in Taiwan and Hong Kong, hasn't been seen in Asia since early 2004 at least.

However, after the initial scepticism, investors were happy enough to buy the bonds, helped by UMC's relatively strong credit and the fact that sole bookrunners Credit Suisse provided enough asset swap to cover the entire deal. The deal also included a short put (after just two years), which resulted in a high bond floor that added further to the attraction.

And on top of that, there have been no convertible or exchangeable bonds by a Taiwan issuer since February 2008 when Asia Cement sold $180 million worth of bonds exchangeable into Far Eastern Textile. That alone would no doubt have prompted CB-focused investors to sit up and take notice.

The two bonds, which together raised $207 million, are exchangeable into common shares of Taiwan-listed Unimicron Technology Corp and Novatek Microelectronics Corp. Unimicron makes printed circuit boards (PCBs) and integrated circuit (IC) carrier products, while Novatek, which was spun off from UMC in 1997, active within flat panel display solutions and image processing-related products.

The shares that will be issued in case they are exchanged, account for about half of UMC's holdings in each of these companies. Since the number of underlying shares was fixed, the final deal sizes depended on where the exchange premiums were fixed and thus the initial term sheet indicated the deal sizes in the form of a range.   

Aside from the exchange premiums, both deals were launched with identical fixed terms and one CB specialist noted that the combined offering made it possible for investors to buy both exchangeables in the hope that at least one of the stocks will perform.

"Because of the asset swap, this is a real cheap way to play the Taiwan tech theme and by getting two at the same time, you also get some diversification," he said. "It's good timing for this kind of deal since it involves taking very little risk."

Indeed, of the 48 investors who participated in the transaction, sources said 45 submitted orders for both bonds.

The key to the transaction lies in the asset swap, which means that buyers of the bonds had to put up very little cash. Most of the money instead came from the local banks that (via the bookrunners) provided the asset swap. As a result, the yield structure doesn't really matter. Although, for UMC it is of course a good deal as it won't have to pay any interest during the life of the bonds and will be able to buy them back (or redeem them) below par.

According to a term sheet, the five-year bonds can be put back to the issuer on the second anniversary at 99%, giving a negative yield of 0.5%, while the redemption price is set at 97.53%. The deal also has an issuer call after one year, subject to a 130% hurdle.

The exchangeable into Unimicron was the larger of the two deals at $127.2 million, while the Novatek bond raised $80 million. The latter was slightly smaller than the $82.2 million to $85.7 million initial range, since a recent rally in Novatek's share price had resulted in the proposed deal size exceeding the $80 million that the company had approval for. The company took a chance that the regulators would let it slide, but it had no such luck and consequently the deal size had to be reduced after launch.

The Unimicron bonds were priced with an exchange premium of 25% over yesterday's close of NT$40.95, after being offered with a premium ranging from 24% to 29%.

The Novatek bonds were priced with an exchange premium of 22% over yesterday's close of NT$89, after being offered with a premium ranging from 19% to 24%.

The sources said the premiums could possibly have been pushed slightly higher, but the strong share price gains for both stocks yesterday -- Unimicron was up 6.9% and Novatek added 4.1% -- prompted UMC to take a less aggressive approach. Both stocks have tripled this year.

The company has been trying to divest its holding in these two companies -- and others as well -- for quite some time and likely did not want to endanger a favourable outcome by pushing the terms too far. UMC has had a stake in both companies for more than 10 years and before this transaction held 17.95% of Unimicron and 10.33% of Novatek.

The exchangeables were marketed with a credit spread of 165bp over Libor, full dividend compensation and a stock borrow cost of 5%, as there is no borrow available in Novatek and very limited in Unimicron. This, in turn, means that investors cannot employ a pure arbitrage strategy on these bonds -- i.e. they cannot hedge the equity option.

This gave a bond floor of 93.8% for both issues and an implied volatility of close to 31% for the Unimicron bonds. The implied vol on Novatek was slightly lower at 29.2%, which one source said makes sense in light of lower liquidity and zero stock borrow.

The bookrunners capped the order size to 10% of the total deal, but even so, the combined deal was about 3.5 times covered. Not surprisingly given the structure, most of the investors were hedge funds, although some long-only funds also participated. No geographical breakdown was available, but the bonds were not offered to onshore US investors.

UMC said it would use the money to expand its fabrication facilities, but didn't specify. However, the key purpose of this transaction was to divest part of its stakes in Unimicron and Novatek.