Joint global underwriters Nikko Citi, Daiwa Securities SMBC and Goldman Sachs underwrote the placement of 170 million government-owned shares to domestic and foreign investors on Monday in the biggest follow-on share sale year-to-date.
For Chuo Mitsui, one of the leading trust banks in Japan, the sale marks one more step towards managerial independence. The shares, representing 14.6% of its total outstanding common shares, had been converted from the 47.8 million convertible preference shares held by the Resolution and Collection Corporation, a subsidiary of the Deposit Insurance Corporation of Japan, before being sold in a joint 144a and Reg-S transaction. All the proceeds from the sale will go to the government.
The government will exit Chuo Mitsui completely by this time next year, under the terms of the convertible preference shares it bought at the time of its capital injection in 1999. The shares have a mandatory 10-year term.
The sell-down was priced at Ñ609 per share, translating into a 2.1% discount to Monday's closing price. The share price held above the placement price yesterday, falling 1.8% to Ñ611. It also slightly outperformed the Nikkei 225, which closed down 2%.
"Investors were reassured by the bank's lack of exposure to US subprime, as well as its very limited exposure to the Japanese consumer finance industry, which has been hurt by regulatory changes. They were also attracted to its expanding gross operating margins and its increasing efficiency," says Bruce Wu, co-head of Nikko Citi's equity capital markets division.
Distribution was split 65% to institutional investors and 35% to domestic accounts. Domestically, Nikko Citi and Daiwa distributed 35% of the deal each, while Goldman Sachs distributed 5%. Internationally, the joint leads each distributed 30%. The balance was sold by the subordinate houses involved in the deal. Of the total demand, 60% was generated from domestic retail investors, 5% from domestic institutions and 35% from international institutions.
The retail tranche and the domestic institutional tranche were both about two times subscribed, while the portion of the deal set aside for international institutional investors was 6.5 times covered.
A rival banker pointed out that the long build-up to the trade û it was launched on June 30 û gave the market plenty of time to adjust, while the fact that the stock is large and liquid also contributed to the success of the deal.
While the investing public was helping repay the government by buying into the deal, Chuo Mitsui itself bought back 85.5 million convertible shares from the RCC for Ñ180 billion earlier this month. These shares will be cancelled, which will reduce the stock overhang represented by the government stake. But the governmentÆs remaining stake, calculated theoretically by converting the preference shares into common stock, is still quite large at about 26.4% of the total issued common stock.
Following these two transactions Chuo Mitsui has repaid the government some Ñ280 billion. ThatÆs a huge sum given that Chuo MitsuiÆs net profit was only Ñ72 billion in the 2007-2008 fiscal year. The profit fell almost 40% from the previous year, mainly on the back of a slowing real estate brokerage business. The company also lost a relatively small Ñ5.2 billion due to subprime exposure.
The bank financed its acquisition of the convertible preference shares through its capital reserves, which stood at Ñ245 billion earlier this year. The downside of this method is that the funds used to buy the preference shares are not available for other contingencies.
Pessimists could argue that the current sale means the government does not feel a better opportunity will come along. According to a statement by Chuo Mitsui in April, it was the government which approached the bank regarding the sell-down. Indeed, according to figures from Hitoshi Mochizuki of the Japan Centre for Economic Research, the longer the government waits, the more it is losing out. He calculates that at the end of 2007, the governmentÆs unrealised gains in the bank were down to Ñ1 trillion, from almost Ñ3 trillion in October 2006.
Chuo Mitsui got a Ñ400.25 billion injection of public funds back in 1999 to help after it had merged with several other ailing banks. While welcome at the time, such capital injections are a poisoned chalice for the banks, since the government gets significant rights in return. Management has to meet profit targets or be replaced, and they must also cope with requirements such as making a quota of loans to small- and medium-sized businesses. Most managers would be very happy to see the end of that interference.
The government too will likely not be displeased with the transaction. With the conversion price of the preference shares at Ñ450, they are well in the money at the price of Ñ609. ThatÆs a solid gain, although much smaller than what it could have made in the past. The stock reached a high of Ñ1,118 earlier this year, and has averaged around Ñ800 over the past year. Still, given that the bank has made progress in reducing government control, while the government has made a profit, both parties should recognise this as a satisfactory deal.
In the first half of 2008, follow-on equity volumes in Japan fell 77% to $2.5bn (22 deals) from $10.8bn (75 deals) in the same period last year, according to Dealogic. That makes follow-ons the worst performing category among all the investment banking activities.
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