This time, however, terms looked slightly less aggressive which was seemingly confirmed by the fact that the offering was five times covered at the cheap end and that the bonds were quoted at 100.5 in the grey market following the pricing early last night. The Singapore-listed companyÆs good track record and expectations that it will embark on more earnings enhancing acquisitions likely helped attract investors, but according to sources, CB players were also drawn to the deal simply because it offered diversification away from Mainland real estate plays.
Since the first such deal in January this year, there have been six renminbi-denominated CBs sold to the international market with four of them coming from the property sector. Over the past month, there have also been several property-related CBs in other currencies as well as placements, which have resulted in a bit of market fatigue for the sector and made investors more sensitive to price.
The Delong deal, which was arranged by Citi, was offered with a fixed conversion premium of 35% over the S$3.30 closing price at yesterdayÆs morning session. The shares were suspended in the afternoon to carry out the transaction.
While still quite high, CB premiums over the past month have typically been set at 45% to 50% - some even higher - making this one look quite reasonable. However, DelongÆs share price has risen about 140% already this year in response to improving steel prices, which could make further gains a bit more of a challenge. If the share price continues to perform strongly, the issuer can call the bonds after two years, subject to a 125% hurdle.
The bonds, which pay no coupon and were issued at par, have a five-year maturity but can be put back to the issuer on the third anniversary for a yield of 3%. They were offered to investors with a wide yield range of 2.375% to 3.375%.
The final yield is higher than on the other renminbi-denominated bonds, which would have been partly due to the fact that yuan swap rates moved quite a bit higher after China raised its official one-year deposit rate by 27 basis points and the lending rate by 27 basis points last Friday. If fully converted, the CB will also account for a massive 80% of DelongÆs current free-float, which means some extra incentive may have been needed to ensure the market would be willing to absorb it all.
In addition, one source says the company was conscious of the poor performance in the secondary market by SPG Land, New World China Land, Greentown China and Gome, and wanted to make sure it got a better treatment.
ôThis company is a first time issuer and it wants to demonstrate that it is a responsible user of the capital markets so that it will be able to come back as the consolidation story develops,ö the source says. The fact that the bonds traded up slightly last night, suggests it was able to achieve that without leaving too much on the table, he adds.
About 75 investors were said to have submitted orders. Since it isnÆt really possible to hedge either the credit or the equity, virtually all the participants would have bought the bonds because they believe in the equity story. And according to analysts that story is a positive one as Delong is a low-cost producer with a good acquisition track record that will likely be at the forefront of the consolidation trend in ChinaÆs steel industry.
The size of the bond issue is Rmb1.34 billion ($175 million), but there is also a Rmb191 million ($25 million) greenshoe that could boost the total funds raised to $200 million. According to the term sheet, the money will be used for core business expansion and for the funding of possible strategic investments, joint ventures or acquisitions, or alternatively for general corporate purposes and working capital.
The underlying assumptions include a credit spread of 370bp, although the bookrunner was said to have provided only a small amount of credit bid at that level while indicating that the appropriate longer-term level for Delong is more like 350 basis points. The stock borrow cost was set at 5% and the divided yield protection at 5%.
This gave a bond floor of just under 95% and an implied volatility of 33%. The latter is quite high in light of the modest dividend compensation, but does compare with a historic volatility of above 50%. Still, such comparisons are rather academic since you cannot short-sell the shares.
A China-based analyst covering the company says the sale of the CBs suggests Delong may be planning more acquisitions.
ôItÆs quite hard to get approval to expand capacity in China so the only way to grow the business is through M&A. If this deal can generate expansion it will be quite positive,ö he says.
Delong, which specialises in the manufacturing and trading of hot-rolled, mid-width steel coils, did commission a second hot-rolled coil (HRC) production line in mid-December 2006, which helped raise its annual production capacity by 50% to 2.4 million tonnes. It also allowed the company to move up the value chain through the production of HRCs of higher grade specifications with higher selling prices.
This contributed to a 131% year-on-year increase in net profit in the first quarter to S$34.6 million ($23 million), while revenues rose by 32.2% to S$272.5 million ($179 million). The net profit margin widened to 12.7% from 7.3% in the first quarter 2006. The company said it expects its second quarter profit to be significantly better than the first quarter performance.
The company is also benefiting from a strong recovery in steel prices since the beginning of this year. In connection with the first quarter earnings release last week, Delong Chairman Ding Liguo, who is also the controlling shareholder, noted that international steel prices are expected to continue rising in tandem with increasing demand and that demand for steel in China is expected to grow at 10% per year for the next two years.
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