Shui On Land upsizes renminbi-denominated CB to $400 million

Chinese property developer Shui On Land on Friday exercised the entire upsize option on its renminbi-denominated, but US dollar settled, convertible bond issued earlier in the week, increasing the deal size to Rmb2.7 billion ($400 million). The CB, which by Friday afternoon was trading at about 102.50, was initially sold at a size of Rmb2.04 billion ($300 million).

The bonds attracted good demand from hedge funds and achieved the highest conversion premium on an Asian CB since March 2008 thanks to the provision of a synthetic stock borrow facility. The latter was achieved through a HK$1 billion ($128 million) equity swap between Standard Chartered (the sole bookrunner for the CB) and a company owned by Shui On Land’s chairman. The short position created by that swap was then passed on to the CB investors to allow them to hedge the equity option.

Equity swaps have been used by four other CB issuers in Asia since the onset of the financial crisis in 2008 saw the availability of asset swaps dry up, but this is the first time that the swap has been down with a major shareholder, rather than by the issuer itself. One benefit is that the company doesn’t have to mark-to-market the swap, and thus will be able to avoid the earnings volatility that can arise as the share price moves up and down.

However, CB specialists note that there are ways that a company can do an equity swap without mark-to-marking it, and therefore the only real difference between this deal and those done before it, is that here the company didn’t use part of the proceeds to buy back shares in the market that were then swapped to create a synthetic short position. In fact, the very first Asian CB that came with an equity swap – a $500 million deal for Country Garden in February 2008 – was sold partly to raise funds that could be used for a share buy-back as the management felt the share price was undervalued.

The Shui On Land CB, which priced on Tuesday evening last week, was launched with a fixed conversion price of HK$4.87, which worked out to a conversion premium of 36.4% over that day’s closing price of HK$3.57. The reason for deciding on the conversion price first had to do with the fact that the Hong Kong-listed company doesn’t want to sell shares below its adjusted IPO price from September 2006, which works out to HK$4.86 after taking into account dividends paid in the form of equity and a share split since then. When the company did a top-up placement in June last year, it also fixed the price at HK$4.87 per share.

The bonds have a five-year maturity, but can be put back to the issuer after three years. The coupon was offered in a range between 3.5% and 4.5%, and fixed at the wide end. A source said it was pretty clear from the outset that that’s where it would end up. The deal came with a par-in, par-out structure, meaning the yield-to-put and maturity will be the same 4.5%. There is an issuer call after three years, subject to a 130% hurdle.

Standard Chartered marketed the CB at a credit spread of 650bp, which was based on where the high-yield bonds issued by fellow real estate developers Shimao Property and Agile Property were trading. The cost for the synthetic stock borrow, which is available for the full three-years until the bond becomes puttable, was 1% and the CB investors will be compensated in full for any dividend payouts.

This gave a bond floor of 94% and an implied volatility of 17% -- compared to an historic volatility of 29%-30%.

According to a source, the deal attracted more than 40 investors and was oversubscribed at the wide end of the coupon-range when the order book closed after about 3.5 hours. About three-quarters of the demand came from Asia, with the rest generated out of Europe, and hedge funds accounted for some 60% of the order amount – a direct result of the availability of stock borrow as this allows them to play the technical aspects of the CB without worrying too much about whether the share price will make it worthwhile converting the bonds into equity. Private banks and outright investors were also buying, although for them the key attraction was the high dividend yield of about 5%. Proprietary trading desks were also said to have been among the investors making up the 40% of the demand that didn’t come from hedge funds.

The CB was quoted just over par straight away, which the source said was partly due to the fact that the synthetic stock borrow left the CB investors a bit too short. Therefore, they had to buy back some shares in the market, contributing to a 1.1% gain in the share price the day after the deal, even as the Hang Seng Index fell 1.5%. The share price posted further gains on Thursday, but then eased back on Friday to end the week at HK$3.61.