Sinopec raises $3.5 billion from A-share CB

China Petroleum and Chemical Corp, better known as Sinopec, has raised Rmb23 billion ($3.5 billion) from a six-year domestic convertible bond, which marks the largest equity or equity-linked transaction in Asia year-to-date.

It is also the largest CB in China after Bank of China’s record-breaking $5.9 billion deal in June last year and Industrial and Commercial Bank of China’s $3.7 billion offering a couple of months later. Like these two transactions, the Sinopec CB is convertible into domestic A-shares only. Sinopec also has H-shares listed in Hong Kong.

According to a source, the deal was heavily oversubscribed following the bookbuilding on Wednesday with more than 2,000 investors submitting orders. The level of interest was so large, in fact, that it prompted a rush for financing in the interbank market, which has pushed up the overnight repo rate some 300 basis points since the deal was announced late last Thursday.

Interestingly, investors seemed completely undeterred by the fact that Sinpoec’s share price has taken a hit this week as the unrest in Libya has sent oil prices over $100. With most of its businesses in downstream refining, rising oil prices are generally negative for Sinopec. However, the scarcity of liquid CBs in China clearly overshadowed any such concerns. Aside from the huge deals from BOC and ICBC last year, most other China CBs tend to be no more than $200 million to $300 million in size. This scarcity tends to result in significant gains on the first day of trading as investors try to add to their allocations.

Aside from domestic institutions there was also quite a lot of interest from international hedge funds, who started approaching the bookrunners shortly after the initial announcement to see whether they could offer any buying opportunities via existing qualified foreign institutional investor (QFII) quotas. Allocations hadn’t been finalised yesterday, but according to a source, about 30% of the demand came from trusts, including QFIIs, 25% from mutual funds, 25% from insurance companies and 20% from securities firms.

Domestic Chinese CBs are different to other Asian CBs in that they are much more equity-like, in other words they are issued and bought on the premise that they will be converted to equity well before maturity. To fit that purpose, they have very low conversion premiums as well as early calls and tend to come with step-up coupons as the issuer is happy to offer higher coupons towards the end of the life of the bond (as it isn’t expected to survive that long) in exchange for low coupons initially. The reason why issuers don’t sell equity straight away has to do with the strict price restrictions that dictate that a share placement cannot be priced below the latest close or the 20-day volume-weighted average price, whichever is higher. This means companies cannot offer new shares at a discount to the market price, which makes it a difficult sell. CBs are subject to the same rules, but because the bonds will be converted in the future, investors will typically be able to buy the shares at a discount to the market price at the time.

Meanwhile, Chinese regulators have been pushing issuers to sell CBs instead of bonds with warrants, which were previously quite popular. The latter instruments are similar to CBs in that they give holders the option of buying equity at a pre-agreed price in the future. However, the bonds and warrants can be traded separately, and typically end up with different investors. As share prices have tumbled in recent years, investors left holding the warrants – often retail investors -- have ended up losing a lot of money, as they haven’t any downside protection (as that lies with the bond portion which is held by a different investor.) Hence, the regulators prefer the use of CBs as they are safer for investors.

Initially, 60% of the Sinopec CB was offered to existing shareholders. The source said about half of that was taken up, which left about 70% of the total deal to be sold through the bookbuilding exercise on Wednesday this week. Goldman Sachs Gaohua was the sole sponsor of the offering and joint bookrunner together with Citic Securities, China International Capital Corp, Credit Suisse Founder Securities, Guotai Junan and UBS.

The six-year deal came with fixed terms, including an annual coupon that starts out at 0.5%, but will step up on each anniversary, to 0.7%, 1.0%, 1.3%, 1.8% and 2.0%. The redemption price of 107% (which includes the final 2% coupon payment) will result in a yield of 2%. However, given that the bonds are expected to convert long before that, not many investors look at the yield.

The bonds can be converted into shares at Rmb9.73 apiece, which equalled a 5% premium to last Thursday’s close of Rmb9.27. However, with Sinopec’s A-share price having fallen 7.8% in the past five days, that premium has now widened to 13.8%. The issuer can call the bonds after the first six months, subject to a 130% hurdle.

While that premium is very low compared with other Asian CBs, it is consistent with other domestic Chinese converts – or even a bit higher. ICBC priced its CB at a 2.9% premium, while BOC offered a premium of just 0.2%.

Sinopec has said it intends to use the money raised primarily for capital expenditures, including the upgrade of two oil and gas pipelines and an oil refinery, and the construction of a new ethylene plant.

The successful transaction can be expected to increase the interest in issuing domestic CBs. Last month, China Shipping Development said that it plans to issue up to Rmb3.95 billion of CBs convertible into A-shares to pay for a number of new tankers and bulk cargo carriers. The deal still needs approval from both regulators and its existing shareholders, which suggests it will take another six to nine months before it actually hits the market.