Hedge fund manager Och-Ziff Capital Partners has agreed to invest $150 million in Hong Kong-listed Xinyi Glass through a so-called Pipe deal — a private investment in a public-listed entity. It will also subscribe to five-year warrants and a bond option in Xinyi Glass’s unlisted subsidiary Xinyi Solar at a value of $30 million.
The combined deal will allow the Chinese glass manufacturer to replenish its capital at a lower cost than it would be able to in the public markets, and will give Xinyi Solar the means to repay a shareholder’s loan after plans for an initial public offering were called off late last year.
Xinyi Glass is involved in the production and sale of high-quality float glass, solar glass, automobile glass and energy saving construction glass products in China and abroad. The company describes itself as one of the market leaders in the glass industry and says its main growth drivers are the demand for energy saving construction glass in China and aftermarket automobile glass in overseas markets.
According to an announcement late last week, Och-Ziff will spend HK$388 million ($50 million) to buy approximately 82.7 million shares at HK$4.69 apiece. The price per share translates into an 11.2% discount to Xinyi Glass’s closing price on Wednesday last week, or a 6.4% discount to the average closing price in the past 10 days. It will give Och-Ziff a 2.2% stake in the company.
It will also buy HK$776 million ($100 million) worth of five-year zero-coupon convertible bonds that can be converted into an approximate 3.3% stake in the company at a price of HK$6 per share. The conversion price represents a 13.6% premium versus last Wednesday’s close of HK$5.28 and a 27.9% premium versus the equity subscription price. The CB was issued at a price of 99.75 and offers a 4% yield-to-maturity.
In the announcement, Xinyi Glass said the investments provide “a good opportunity to access financing for the group without significantly increasing its finance costs; and to introduce an independent and significant investor who shares the business vision of the company.”
The company said it will use the money to pay for capital expenditures, future investments in potential projects, and to repay existing debt. A portion will also be used as general working capital. In the past the company has been relying primarily on bank lending to cover capex and other investments. In 2011, Xinyi Glass’s finance costs increased by 375% to HK$32.5 million after it took out a third syndicated loan of HK$1.0 billion. Effective interest rates also rose due to the tight money market conditions.
As of the end of last year, Xinyi Glass had bank loans totalling HK$4.3 billion, which was up 58.5% from the end of 2010. Its net debt gearing increased to 42.3% during the year from 31.8% at the end of 2010.
The CB in particular is a good deal for Xinyi Glass, according to a source, as the company would likely have to pay a coupon of 4% to 5% if it was to issue a similar deal in the public CB market. And a zero-coupon CB is really not achievable for a non-investment grade mid-cap company in the current market environment, the source added. The conversion premium is also quite high when compared with the equity subscription price, which would have been the reference price if the company had done a concurrent equity placement and CB in the public market.
Xinyi Glass has the right to force conversion of the bonds into equity according to a pre-set schedule, if the share price rises above certain trigger points ranging from 125% of the conversion price in year one to 165% in year five. The forced conversion will be staggered over the five-year maturity and each conversion will be for a portion of the bonds only.
At the same time, Och-Ziff is getting the opportunity to buy shares in the company at a discount to today’s shares price, and to potentially increase its stake at a discount to the future share price as well. If the CB is converted into equity in full, the hedge fund will own 5.5% of the company. The deal indicates that Och-Ziff is positive on the company and the equity story and, according to sources, it was the hedge fund itself that approached the company about the investment a couple of months ago.
Meanwhile, the pre-IPO investment into Xinyi Solar is giving Och-Ziff the chance to buy into the solar glass manufacturer at a favourable price before its Hong Kong listing, which is still -part of the group’s longer-term plans. However, Och-Ziff has also agreed to buy shares in a future Xinyi Solar IPO, at the IPO price, equal to a 9.9% stake in the company — essentially acting as a cornerstone investor.
The subscription cost for the 98.1 million warrants is HK$1.94 million and they come with an exercise price of HK$2.38 per share, which will translate into a total acquisition cost of HK$233 million ($30 million). Och-Ziff is expected to convert the warrants into a HK$233 million non-interest-paying bond before the potential IPO of Xinyi Solar to comply with the Hong Kong stock exchange rules regarding pre-IPO investments.
However, contrary to most other pre-IPO investments, this one doesn’t put any pressure on the company to complete a listing within one or two years through the use of various features such as higher interest rates if the target isn’t achieved. That leaves Xinyi with a lot of flexibility with regard to the timing of a future spin-off.
The investments come after Xinyi Glass’s share price fell by 71% between early May and late September last year amid a volatile operating market. The market was particularly challenging within float glass, which saw greater price competition due to an increase in production capacity by other Chinese manufacturers, while tighter monetary policy resulted in a slow-down in demand. Rising inflation in China also led to higher raw material and production costs, putting pressure on gross margins. The challenges were evident in the fact that net profit fell 19.5% to HK$1.3 billion in 2011 despite a 29.3% increase in revenues to HK$8.2 billion.
However, the share price has recovered somewhat since the low-point in September and before the Och-Ziff investment was announced on Thursday morning, it was up 18.7% so far this year. The stock fell 3.8% on Thursday and another 0.2% on Friday, leaving it at HK$5.07.
Xinyi Solar was initially planning to raise up to $465 million through an IPO, based on a maximum market cap after listing of $1.55 billion and a plan to sell 25% to 30% of the company, according to a statement by Xinyi Glass in October last year. Shareholders approved the spin-off plan in early November and Citi and J.P. Morgan started pre-marketing the deal immediately after that. However, the potential deal size had then dropped to about $150 million, according to sources, as the company was forced to face the reality that the solar power sector globally was largely out of favour.
Prices for solar power panels and other solar components fell significantly in 2011, eating into margins and forcing producers to slash their earnings forecasts. And as a direct result, valuations of the solar power companies also fell sharply. After a week of pre-marketing, Xinyi Glass announced it had decided to postpone the spin-off and IPO of its solar glass unit, Xinyi Solar Glass, after a week of pre-marketing due to “the recent volatility in the global capital markets and the prolonged adverse impact of the sovereign debt crisis ... on the global solar energy industry” which was making the future developments of the solar power and solar glass industries uncertain.
The combination of a Pipe deal and a pre-IPO investment is quite rare and likely helped Xinyi Glass achieve even more favourable terms on the investment in the listed entity. Citi was the sole arranger of the deal.
