Tata Motor returned to the Indian CB market for the first time in nearly a year yesterday (Monday) with one of the most expensive equity-linked offerings by an Asian company in recent memory.
Its achievement was considerable given that at $400 million the issue size represents two-thirds of all Indian issuance since 2001. There have been just six deals and only one has topped $150 million. It is the largest deal on record.
What Tata's deal has is rarity value, blue chip status and first mover advantage ahead of a growing pipeline of Indian companies planning to tap the equity-linked market. Specialists say investors' desperation to play the Indian equity market was the primary driver of the deal, which offers liquidity and easy entry into what is often considered a difficult underlying market.
One of its more clever aspects was the tranching, which broadened the potential investor base. Under the lead of four banks - Citigroup, JPMorgan, Merrill Lynch and Morgan Stanley, the group split the deal into a $100 million tranche (A) and $300 million tranche (B).
Tranche A was viewed by the company as quality equity and had a low premium and aggressive yield structure.
Pricing was completed at par, with a zero coupon and redemption at 97.53% to yield minus 1%. There is no put option on the five-year deal and a call option after one-year with no hurdle.
This represented the tight end of a range encompassing a yield of minus 0.25% to minus 1%. The conversion premium was also priced at the tight end of a 12.5% to 17.5% range and came at 17.5% to the stock's Rs487.75 close.
Tranche B, which raised $300 million, was designed to raise cheap financing for the company, which will still be happy if does eventually get converted since the hurdle was set extremely high.
Terms comprise an issue price of par, 1% coupon and redemption price of 121.78%, to yield 3.75%. Again there is no put option and also no call option.
The conversion premium was fixed at a staggering 60% premium to the stock's spot close. In addition to this, there is a contingent conversion feature, which means the deal cannot be converted unless the stock price is 110% of the accreted price in year one. This value falls steadily until 0% in year seven.
Underlying assumptions for tranche A comprise a bond floor of 72.12%, theoretical value of 99.3% and implied volatility of 50.2%. This is based on a credit spread of 170bp over Libor, 5% borrow cost, dividend yield of 1.6% and volatility assumption of 47%. There is no adjustment on the dividend if it is less than 5%.
Specialists say that although most funds modeled zero borrow into their assumptions, it is possible to hedge the company's GDR and there is also a fairly liquid futures market with open interest of about $50 million to $60 million per day. The credit is rated BB by Standard & Poor's with stable outlook.
Underlying assumptions for tranche B comprise a bond floor of 83.6%, theoretical value of 97% and implied volatility of 53%. Because of the additional two-year maturity, the credit spread bumps up to 200bp.
Both tranches had exceptionally low bond floors, no theoretical value and implied volatility ratios well through historic levels. How sustainable such valuations are for other companies in the pipelines is open to question.
Nevertheless both tranches on Tata's deal went on to close multiple times oversubscribed. Although a 10% cap was placed on orders, each tranche attracted around $2 billion in demand, with over 400 investors in tranche A and 200 in tranche B.
The Indian CB market has come a long way since last July when Tata Motors re-opened it with a $100 million deal five-year, non-puttable transaction. This had a 1% coupon and a yield-to-maturity of 4.1%. The conversion premium was settled at 17.5%.
Then there was a far more defensive bond floor of 92.3%, comfortable theoretical value of 106% and implied volatility of 27%.
Since then the deal has traded up to a bid price of 140%. Somehow it seems unlikely investors will enjoy the same upside from the new deal.
Tata's success on both occasions underlines that the days of credit enhanced deals for India's best companies are long gone. Indeed, low bond floors indicate that investors no longer want defensive structures but are searching for equity upside.
Few accounts are said to have wanted asset swap.
Year-to-date Tata is down from a high of Rs563.25 in late January, but up from a low of Rs416 in late March. Part of the fall was attributed to the CB fundraising plan, which spooked a number of analysts and investors who wondered why a company with significant free cash flow would need to raise so much money.
Tata has a capex plan of over $1.5 billion per year, but can easily fund the entire amount from free cash flow. Management have since said they want to raise funds to pay for an acquisition in Korea and plant expansion in India. There is certainly plenty of room on the balance sheet since net gearing stood at only 20% pre deal.
For its most fervent supporters, Tata is viewed as the next Hyundai Motor. And indeed its first overseas acquisition was a $102 million purchase of Daewoo Commercial Vehicle, which has a 26% market share in Korea.
The company is also rumoured to be the on verge of signing a joint venture with Brilliance China to make passenger cars on the Mainland. In its home market, Tata has a 65% share of the medium to heavy vehicle sector and a 15% share of the passenger market, where it has a much shorter history.
It is currently trade on a PE multiple of about 22 times 2004 earnings and an EV/EBITDA multiple of 9.5 times, below its five-year historic average around the 12 times level.
