Chartered Semiconductor began to address its aggressive financial leverage on Friday (July 22) with the placement of $250 million through a convertible redeemable preference share issue (CPS) and the launch of a $450 million SEC-registered bond, which is scheduled to price later this week.
Goldman Sachs underwrote the CPS issue and took a proprietary position in the deal, which was placed with just a handful of other accounts. The US investment bank is also global co-ordinator of the bond issue alongside Citigroup as joint bookrunner, plus ABN AMRO and Bank of America as co-leads.
Proceeds from both transactions are being used to fund a tender offer for the group's outstanding convertible issue due April 2006. A tender offer for $450 million of the CB will take place immediately after the scheduled August 3 settlement date of the bond issue.
However, it can be upsized to the full $664 million redemption amount of the CB ($575 million at issue) should the company approve the CPS issue at an EGM on August 17. An EGM had to be called because the CPS represents a new class of shares on the company's balance sheet and requires a 75% vote in favour.
The CPS issue also marks a first for non-Japan Asia and was used for two main reasons. Firstly Chartered did not want to raise straight equity and immediately dilute investors because it believes its share price is too low.
Secondly the company has swung into debt reduction mode and did not want an instrument on its balance sheet that would classify as debt. A CPS issue counts as equity, but presents structural difficulties for a company like Chartered.
This is because CPS transactions typically pay dividends. But Chartered cannot pay dividends while it is still running at a net loss.
Goldman got round this problem by splitting the transaction in two. Tranche A has a face value of $211 million, with a five year maturity and call option in year two subject to a 125% hurdle.
The transaction was issued and redeems at par. It is also convertible at a 20% premium to the VWAP of the company's share price in the five days ahead of its EGM on August 17. There is no put option.
Tranche B gives investors the yield that could not be structured into tranche A because the company does not pay dividends. This tranche comprises 10 semi-annual payments of $4.56 million that have a net present value of $39 million.
Hence tranche B has a face value of $39 million and amortizing structure that sees the issue redeem at zero. This equates to a running yield of 3.65%.
Specialists say the structure is extremely difficult to value in the traditional sense as there is no credit underlying the CB. It is also complicated by the fact that the structure can be redeemed into ordinary shares or cash. However, it can only be redeemed into cash if the company has positive shareholder funds.
"This is one of the biggest risk factors underlying the deal," explains one specialist. "Say you assume the credit spread of a straight CB would be about 125bp to 150bp over Libor. What you then have to calculate is the recovery rate of a defaulted CPS issue.
"If you assume a recovery rate of about 20% then you would need five times the rate of a senior bond to hedge that risk," he adds. "That brings the credit spread out to the 625bp to 650bp mark."
On this basis, the deal has a bond floor in the high 60's to low 70's. But specialists say the calculation is purely theoretical since there will be no asset swap market for a CPS issue.
Investors are expected to be able to delta hedge their positions, however, since the company will make borrow available after the EGM.
Based on a yield of 3.65% specialists say the new CB is about 40% cheaper for Chartered than the outstanding one. This latter deal was launched in 2001 shortly before the semiconductor went into a downturn.
It is currently bid at 112%/133% on a conversion premium of 249%. At launch it was priced with a premium of 33% to the stock's then spot price of S$4.90. Chartered is currently trading around the S$1.44 mark.
Pricing of the original deal came at par, with a redemption price of 115.49% and coupon of 2.5% to yield 5.25%.
The new vanilla bond deal is likely to have a five and 10-year tranche structure and should price later this week following the completion of roadshows in London and Los Angeles on July 27 and Boston and New York on July 28.
The issue was assigned ratings of Baa3/BBB- by the two agencies on Friday. Securing an investment grade rating was a major achievement for Chartered - it was undoubtedly helped by the triple-A rating of its ultimate parent Temasek via Singapore Technologies, which owns 60% of the group.
Both agencies highlighted the company's weak financial structure, which has been put under pressure by several years of high capex expenditure and concurrent losses.
The company sees the new bond deal as a means of terming out its debt profile and reducing its borrowing costs at a time when interest rates are low. Chartered currently has a gross debt position of $1.96 billion and net debt position of $891 million.
This equates to a net debt to capitalization ratio of 40% and net gearing of 66.6% - high ratios for such a volatile sector.
Analysts have mixed views about the company. Many have neutral positions following the stock's recent outperformance. Having touched a 52-week low of S$0.895 in late December, it has risen 46.94% year-to-date.
Chartered is now trading at about 1.7 times forward book and analysts are not sure what will be the next catalyst to re-rate it higher. The company is still running at a net loss and although second quarter results were slightly better than expected, a number of analysts remain unsure when it will turn profitable again.
Chartered reported three years of consecutive losses after 2001, with one brief spell of profitability for the first three quarters of 2004. Analysts say the company was harder hit than its bigger Taiwanese rivals - TSMC and UMC - because it has historically relied on IDM rather than fabless customers.
At a time of an industry downturn, these clients are the most likely to cut orders and return manufacturing in-house. However, Chartered continued to spend heavily to make sure it kept its technological roadmap on a par with its rivals. As such it has accounted for 17% of total R&D spend in the foundry sector over the past three years, but only 6% of global sales.
In 2002, Chartered also forged an agreement with IBM and has been co-branding technologies below 01.3 micron in order to win former IBM clients. This alliance covered the company's move into 90nm and now extends further down the technological roadmap to 65nm and 45nm.
Both of these factors may now play to the company's advantage if the semiconductor cycle is turning. However, analysts say the key to Chartered's profitability lies in its ability to ramp up its new Fab 7, which became operational in June.
On Friday, the company released second quarter figures, which revealed a net loss of $67.1 million on revenues of $194.1 million. The company says it expects to record a net loss of between $42 million and $52 million during the third quarter.
It also expects its utilization rate to increase from 65% in the second quarter to 68% to 72% by the end of the third. During the first quarter, it reported a utilization rate of 59%.
Breakeven for the company's operations will come at a utilization rate of 85%. However, some analysts believe the company will be able to breakeven at 75% thanks to falling depreciation - a major cost on any tech company's balance sheet.
