The Taiwanese convertible market entered a new era late on Tuesday night with the pricing of an increased $375 million convertible for Fubon Financial Holdings. Prior to Fubon, virtually all Taiwanese deals were small tech-related offerings and under Taiwanese law, investors had to convert their bonds into Entitlement Certificates ahead of the underlying stock, a laborious process which could take up to three months. Fubon, by contrast, has not only offered investors size and sector diversification, but is also the first offering from the Island Republic benefiting from a legislative change late last week allowing investors to convert directly into shares.
Fubon is the first of three deals expected from the country's newly created financial holding companies and unsurprisingly its stand-alone credit strengths and first mover advantage enabled it to secure tight terms after a 15 hour marketing period, with books closing eight times oversubscribed.
Led by Credit Suisse First Boston and Salomon Smith Barney, the deal has also set a new record as the largest outstanding convertible from Taiwan, although this is likely to be short lived given that there is a $600 million issue for the China Development Industrial Bank (CDIB) waiting in the wings. Goldman Sachs and UBS Warburg are said to have won the mandate over two other shortlisted banks, Deutsche Bank and Morgan Stanley, although this remained unconfirmed as FinanceAsia went to press.
For Fubon, a convertible enables the group to raise more proceeds for its acquisition war chest, but more importantly, it has also been able to unwind the cross share holdings which underpinned its structure prior to re-organisation as a financial holding company in December 2001. The group had been given a three-year SFC deadline to resolve the issue of the legacy shares, which were sitting in the group's five main operating subsidiaries: Fubon Insurance; Fubon Life; Fubon Securities; Fubon Commercial Bank and Fubon Securities Investment Trust.
The transaction is consequently convertible into 373 million Treasury shares and on full conversion all the legacy shares will have been issued back out into the market. The deal adds a further 7.6% to Fubon's free float, which represents 44.5% of the group's outstanding share capital.
Similar to UMC, which also launched a convertible backed by Treasury shares last December, the final maturity had to be kept very short because under Taiwanese law, companies cannot issue dividends into Treasury shares. Final terms for the 2.25 year transaction comprise a zero coupon and conversion premium of 21.2% to a volume weighted average price of NT$33.30 on Tuesday April 2.
The conversion premium puts Fubon into an elite tier of only four other Taiwanese companies able to pierce the 20% mark over the past three years - Hon Hai, Acer Communications & Multimedia, Yageo and most recently UMC. Partly this results from the abolition of the Entitlement Certificates, which should in turn eliminate liquidity risk and push conversion premiums higher across the board in the primary market.
Fubon's deal also has hard no-call for 18 months, thereafter subject to a 130% hurdle. With premium redemption at 107.52%, the deal has a yield-to-maturity of 3.25%, or 70bp through Treasuries.
Having deliberately set out to whet the market's appetite with a smaller than expected issue size of $325 million, strong demand enabled the deal to be upsized to $375 million and should a $55 million greenshoe be exercised as well, total proceeds will be bumped up to $430 million. Alongside the leads, co-leads were Goldman Sachs and Lehman Brothers, with Cazenove, CLSA, Fox Pitt Kelton and FB Gemini as co-managers.
Underlying assumptions comprise a bond floor of 93.5%, fair value of 100.92% and implied volatility of 27.8%. This is based on a credit spread of 190bp over Libor, dividend yield of 1.6%, stock borrow cost of 4% and 30% volatility assumption.
For outside observers, the two most striking features of the transaction's valuation are its tight credit spread relative to its BBB-/Baa3 rating and the extremely expensive volatility. Ahead of the assignment of a holding company rating, specialists had expected the group to be rated at the high BBB or low single A level, since the agencies typically rate a holding company with an insurance subsidiary three notches lower. In Fubon's case at an A3 level based on the AA- rating of Fubon Insurance.
It is a view shared by Fubon officials. Group managing director Wing-Fai Ng says, "When we did our own internal credit analysis, we came out with a single A rating and so the ratings we've received from the agencies are certainly lower than we either expected or desired. But we do understand their concerns and particularly about the short history of the financial holding company law in Taiwan. It's only been in existence for about six months and of course it will take time for the regulatory framework to develop fully."
At 190bp over Libor, Fubon falls in line with BBB rated UMC, which is being quoted in the asset swap market around the same level. Some bankers argue that the deal's credit strength and novelty value, meant that up to 95% of funds decided to hold the issue outright, rather than strip the credit portion out. Others, however, say that there has been a fairly active asset swap market, with a percentage of business bypassing the leads.
In total about 200 investors are said to have participated with a geographical split that saw 45% placed in Europe, 35% in Asia and the remaining 20% in the US. At the end of first day's trading the deal was being bid at 100.425%, with about $100 million in traded volume.
In terms of the transaction's volatility, specialists say that it is almost unheard of for an Asian convertible to price right on top of historic volatility. As one comments, "This deal is genuinely different. It was priced very slightly below historic volatility, but at the outset of secondary market trading, immediately went through it. It just goes to show how hot the market is at the moment."
Some observers suggest the reason Fubon appeared to achieve these pricing levels is because the leads miscalculated historic volatility and used one month of data since the group only listed in December. This, however, has been refuted by the leads who say that a basket of all the group's constituent stocks was calculated out as far as 260 days, with volatility coming out at the 32% level.
So too, some have argued that at 3.25% the yield appears very cheap compared to levels achieved this year by some of the better non-investment grade rated tech companies such as Macronix and Siliconware Precision Industries (SPIL). Both issuers have slightly longer deals with two-and-a-half-year puts. Macronix was priced with a yield of 3.55% and SPIL at 2.25%.
Others point out that this is because a higher yield has been used to lift the bond floor. "The more valuable the equity option, the less yield is needed because the bond floor goes down," one banker explains. "Both Macronix and SPIL had some stock borrow available and because they're tech stocks with much higher volatility levels, investors are willing to pay more for the equity option.
"The Fubon deal is fully valued," he adds, "And even for those accounts that might have been able to source some borrow via the GDR, it would have been difficult to extract much more juice."
Year-to-date, Fubon's share price is up 8.22% against a 3.6% gain in the TWSE. Managing director Ng says that the convertible marks the beginning of a second phase in the group's transition from a disparate group of financial services companies into a seamless integrated entity.
Over the short-term proceeds will add to one of the company's more pressing problems of what to do with its excess capital estimated to total NT$40 billion ($1.14 billion), and most of which is trapped in Fubon Insurance and Fubon Securities. The group has applied to make a one-time capital transfer of NT$17 billion up to the holding company where it is likely to be re-deployed to fund new acquisitions particularly on the commercial banking side, which the group has been most active in trying to develop further.
Ng comments that the potential for retail banking in Taiwan is one of the most compelling reasons to buy Fubon's stock. "In Taiwan, there are $800 billion in consumer assets against $500 billion in Korea," he states. "But consumer leverage in Taiwan stands at only 20% compared to 35% in Korea and 50% in Hong Kong and Singapore. There's a lot of potential."
Analysts re-iterate his viewpoint, commenting that the historically fragmented state of the Taiwanese banking sector has resulted in little brand loyalty and hence plenty of opportunity. "At the top end of the market, there are about 450,000 individuals in Taiwan with liquid funds in excess of $100,000 and this segment is growing fast at over 10% per annum," says one analyst. "Of this number, only about 50,000 could be said to be owned any kind of holistic way by individual banking groups."
The second prong of Fubon's strategy is its international expansion through its 50/50 Citi-Fubon joint venture with Citigroup, which now owns 15% of the holding company. Having established the JV two years ago, progress has been relatively slow, but Ng says the group has just received an insurance license in Hong Kong and plans to begin operations shortly.
