Investors pile into Khazanah exchangeable

Investors pile into Khazanah exchangeable
The Khazanah bonds are exchangeable into shares in Chinese department store operator Parkson Retail

Khazanah Nasional last night returned to the equity-linked market with a $358 million exchangeable Islamic bond, which was aggressively priced and confirmed that there is indeed huge investor appetite for deals backed by strong credits. The bonds are exchangeable into Hong Kong-listed Parkson Retail Group and are backed by Khazanah’s remaining 220 million shares in the company – one of the largest nationwide department store operators in China.

The deal attracted more than $1.5 billion of demand and well over 100 investors. It was also priced at best terms for the issuer, including a slight negative yield. This meant it pushed the envelope a bit further than triple-A rated Temasek, which issued two exchangeable bonds in the fourth quarter last year at a zero coupon and zero yield.

The fact that Khazanah is the investment arm of the Malaysian government and therefore viewed as a top-quality issuer was clearly part of the attraction, but the ability to hedge the underlying equity, the lack of equity-linked supply so far this year and continued optimism about the China consumer story all helped draw investors into the deal, sources said. Parkson may no longer be growing at 30% to 40% every year, but it is still viewed as a good story, one source said. However, according to Bloomberg data, 22 of the 28 analysts covering the stock currently have a “hold” recommendation on it. The rest are split evenly between “buy” and “sell”.

This is the first time in four years that Khazanah is tapping the equity-linked market and the fourth time that it sells exchangeable bonds that are compliant with Shar’iah law. The most recent deal, in March 2008, was also exchangeable into Parkson. Indeed, a portion of the shares underlying this latest deal are also underlying the previous bond, of which 55% is still outstanding.

However, the 2008 bonds are well out of the money and are not expected to be exchanged for equity before they mature in March next year. As a result, Khazanah has received approval from Shar’iah scholars to use those same shares to back a new transaction. The 220 million shares account for 7.8% of Parkson’s share capital and at the final terms, the total size of the new exchangeable bond is $357.8 million.

The bonds, or zero periodic payment exchangeable trust certificates as they are called for the purpose of complying with Shar’iah law, have a seven-year maturity, but can be put back to the issuer after three years at a price of 99.25. The long remaining maturity after the put – referred to as a certificate-holder optional dissolution – is a reflection of the fact that interest rates are at record lows right now and Khazanah is taking the opportunity to lock bondholders in for an additional two years at that same rate if they decide not to put the bonds back after three years. The normal practice is to leave only two years after the put, i.e. a five-put-three or seven-put-five maturity. There is also an issuer call after three years, subject to a hurdle of 130%.

The coupon, which on Islamic issues is referred to as a periodic payment, was fixed at zero percent at launch, but the yield was offered in a range between -0.25% and zero percent and the conversion premium came at 25% to 30%. As noted, both were fixed at the issuer friendly end, resulting in a yield of -0.25% and an exchange premium of 30% over Parkson’s closing price of HK$9.71 yesterday. The latter gave an initial exchange price of HK$12.623 – a level that Parkson hasn’t traded above since February 2011.

This is the first non-yen equity-linked deal in Asia with a negative yield since May 2011 when Taiwan’s United Microelectronics Corp sold $500 million of convertible bonds with a yield of -0.25% and a 39% conversion premium. However, that deal was linked to the new Taiwan dollar, although it was settled in US dollars. Looking at dollar-denominated transactions, there hasn’t been any issues with a negative yield since 2009.

The Khazanah bonds traded up to about 101 in the grey market during the two-and-a-half-hour bookbuilding, which boosted investor confidence in the deal even further.

The buyers included a mix of investors, including traditional CB hedge funds and outright investors, but also a lot of cross-over accounts, some credit accounts and some straight equity accounts, one source said. The demand from Islamic investors was lower than on Khazanah’s previous exchangeable sukuk, however, which may partly be due to the fact that they take longer to make investment decisions. Following the real estate crisis in the Gulf region there are also fewer investors looking at asset classes outside of straight bonds, one observer said.

The source estimated the Islamic, or Middle Eastern, demand at about 20% of the total, with Asia accounting for about 50% and Europe the remaining 30%. Khazanah’s latest two Islamic exchangeables – the 2008 deal into Parkson and a 2007 deal into Malaysia-listed Plus Expressways – got about 50% of demand from the Middle East.

The latest bonds were marketed at a credit spread of 150bp, a dividend yield of 2% and a stock borrow cost of 50bp. Sources noted that there is plenty of borrow available in the market, but in case it becomes more difficult to access later on, the bookrunners will provide borrow through a stock lending agreement with Khazanah.

At the final terms, this translated into a 92.8% bond floor and an implied volatility of about 27%, which compares with a historic vol of about 35%.

The deal came after two Hong Kong-listed companies tapped the convertible bond market for a combined $434 million on Tuesday, breathing new life into a market that had seen only three deals so far this year.  The two issuers – 361 Degrees and China Overseas Grand Oceans Group – offered two very different deals in the sense that one of them was viewed as quite expensive (361 Degrees) while the other one was very cheap. Both saw good demand, however, suggesting that investors are happy to use the CB market as a less risky way to gain exposure to Asian equities as the regional markets continue to recover from last year’s slump.

Earlier in the year, CB investors were very cautious about deals that were not hedgeable and said they would prefer to see more paper from high-grade issuers. Khazanah seems to have listened, and its decision to monetise its remaining shares in Parkson a year ahead of the maturity of the initial exchangeable has clearly paid off – if the bonds aren’t exchanged into equity, the company is even getting paid to take investors’ money for at least three years.

Khazanah invested $69 million into Parkson at the time of its Hong Kong IPO in November 2005 and when the Malaysian investment company issued its first exchangeable into the stock it owned about 9.8% of the company. The 2008 exchangeable was sold concurrently with a $96.8 million placement, which reduced Khazanah’s overall stake and left 220 million shares (adjusted for a five-for-one stock split) to back up the $550 million exchangeable.

About 45% of that first bond was put back in March 2011, leaving about 110 million shares still tied up in that exchangeable. The deal is exchangeable into equity at a price of HK$19.45 per share, and given that the stock is currently trading at about half that price it is unlikely that it will ever be converted. However, if the share price were to recover, Khazanah has the option to settle the exchange of both bonds in cash, meaning there is no risk that it will get caught out with too few shares to deliver to investors on either deal.

The exchangeable was jointly arranged by CIMB, Deutsche Bank and J.P. Morgan.

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