To the surprise of some market observers, LG Philips LCD returned to the international capital markets yesterday (April 12) with a $400 million convertible. The deal was launched on a day when the company reported a poorer than expected first quarter operating loss of Won162 billion ($160 million), leading to a stock price decline of 3.8%.
As such, many wondered why the company did not give the market a few days to digest the news and let potential CB investors see how the stock settles.
However, LGP's decision to jump straight into the market is perhaps not that surprising given its burgeoning reputation for failing to time deals to its advantage. Its 2004 dual listing in Seoul and New York missed the top of the last cycle and eventually came in July when the TFT-LCD sector was in freefall. Some now believe it is pricing equity off the bottom of the ensuing down cycle and should have chosen straight debt to fund its capex instead.
Its Taiwanese competitor AU Optronics, on the other hand, has always tried to time the top of the market, in the process providing investors with a reliable indicator of when to sell. It listed on the NYSE in May 2002 at the height of one cycle and filed for its most recent ADR in spring 2004 at the height of the last, although it went on to price the deal about a month too late.
Lead managers of LGP's CB are Citigroup - a long time advisor to the LG group, plus Morgan Stanley and UBS - the two global co-ordinators of its IPO. The three are said to be have been able to build a book that closed about one-and-a-half times covered with participation by just over 60 accounts.
This was not a bad result considering the deal was large by Asian standards and follows a paucity of issuance in difficult global markets for the equity-linked product because of rising interest rates and low volatility levels. Most non-syndicate bankers also thought the terms were fairly reasonable considering how skittish CB investors have become and how divided analysts remain on the prospects for the TFT-LCD sector.
Terms comprise a zero coupon five year deal with a put option in year two-and-a-half at 108.39% and redemption at 117.49% to yield 3.25%. The conversion premium was fixed at 30% to the stock's Won44,950 close.
This represents the outer end of terms, which comprised a put option of two-and-a-half to three years and a conversion premium of 30% to 35%. There is also a call option in year three with a 130% hurdle and a greenshoe of $75 million.
Underlying assumptions comprise a bond floor of 93.2%, implied volatility of 31% and theoretical value of 102%. This is based on a credit spread of 170bp over Libor, 1% dividend yield (the company does not currently pay one, but does not want to adjust the CB in case it decides to do so over the next five years) 5% borrow cost and historic volatility assumption of 35%.
At $400 million, the deal is relatively large compared to the $1.5 billion freefloat, but less so in the context of its $14 billion market capitalization.
Despite the unfavourable market environment, the deal does have a number of factors in its favour. Firstly, it has rarity value both from a country and sector perspective.
There are currently only nine outstanding benchmark deals from Korea and virtually all hail from the telecom sector, or electricity utility Kepco. Most are also more highly rated that LGP, which is currently unrated but viewed as an appealing cross-over credit.
Specialists consequently report huge credit demand for the company especially out of Korea. But they also say there was very little asset swapping in the primary market, as most investors believe spreads are likely to contract. Indeed one competitor bank said it had been prepared to bid for the mandate on a Libor spread of just under 100bp.
Secondly, LGP is clearly the world leader in the TFT-LCD space and while there were a number of deals from second tier Taiwanese manufacturers in 2004, there has not been a tier 1 deal from the sector since the summer of 2003 when Chi Mei came to market.
For those investors who believe the cycle is turning, the CB would offer an attractive entry point. However, the key question is whether the cycle is turning and whether too much optimism has already been priced into LGP's valuation, which will now come under pressure thanks to its bad results?
The stock price has performed well since the company listed at Won34,500 per share in July last year and is trading around 2.5 times 2005 price to book and 1.9 times 2006.
Some analysts consider this valuation rich in the context of conflicting signs about a turnaround in the sector and believe that the Taiwanese tier 1 players - AUO and Chi Mei - currently offer better value because they have not yet caught up. They caution that this may lead to short-term downward volatility in LGP's share price.
AUO, for example, is trading at around 1.7 times 2005 book and 1.5 times 2006. This represents a differential of eight points to LGP on a 2005 price to book basis.
Back in July when LGP listed, the two traded flat to each other at 1.25 times 2005 book. At the time lead managers argued that LGP deserved a valuation premium because of its market leadership, whereas investors had counter-argued that it should come at a discount because the Korean market always trades at one.
Some analysts also believe that LGP has been swept up in the strong performance of the Kospi so far this year, whereas the tech-dominated Taiwanese market has remained in the doldrums to the detriment of AUO.
LGP has been the first of the TFT-LCD manufacturers to announce its Q1 results. Analysts had been expecting losses across the sector and prior to yesterday many were starting to put out buy recommendations on the basis that losses mean the sector is bottoming and will start to re-bound. A number have argued that blended ASP's (Average Selling Prices) will continue to fall in Q2 but will re-bound in Q3.
There have been some positive datapoints to back this up. At the beginning of March, for example, LGP became the first company to institute a price hike when it increased the price of its 17" panels by $3 to $5 resulting in a monitor panel price of $155 to $160. Some of the Taiwanese have since followed suit.
In a research report published in mid-March, Deutsche Bank said that, "panel makers should still expect losses in 1H05, but we believe it is becoming increasingly difficult for investors to resist positive TFT-LCD datapoints. These include rising prices for 17" panels, more aggressive LCD TV ramp up and sustainable panel demand going into 2Q05."
But some analysts said yesterday that they would be revising their view as a result of the severity of LGP's profit drop. The consensus loss forecast had been for only Won95 billion compared to an actual loss of Won162 billion.
To some this will mean that the pain may last longer and cut deeper than the market had been anticipating. To others it will mean that the up cycle will not tick up fast as the market had been hoping. CSFB for one is forecasting a prolonged mid-cycle.
Others are similarly now saying that the next TFT-LCD cycle may take the form of an L rather than a U shape. This argument is based on lack of cost reductions the panel makers can squeeze out and the aggressive capex investments, which continue apace despite oversupply problems.
Industry research specialist DisplaySearch has said that second tier players will not become profitable until at least 2007 because of continuing overexpansion and lack of consolidation. It believes tier 1 players may become profitable in the first half of 2006, but possibly not until the second half. Even at its most optimistic, this is at least six months longer than analysts had been forecasting.
LGP will, nevertheless, have a first mover advantage in this respect since the ramp up of its G6 fab has been much faster than expected and it is predicted to start hitting 60 to 70K per month by the second quarter. It is also switching production at the fab to larger panels and analysts say that 37% of its 2005 output is likely to be geared towards LCD TV production.
