Two Chinese e-commerce companies took full advantage of the latest bull run in the sector at the end of last week with well-received equity offerings on the Nasdaq.
A debut convertible by online gaming company Shanda Interactive was particularly impressive. The base offer size and greenshoe were both upsized and if the latter is fully exercised, the $275 million deal will rank almost twice the size of the $153 million IPO, priced only five months ago.
Both the IPO and convertible were led by Goldman Sachs and the difficult passage of the former relative to the ease of the latter, stands testament to the incredible volatility of the sector. This volatility was the lynchpin of the convertible, whose structure differs significantly from classical Asian equity-linked deals from Taiwan.
The 10-year deal has a par-in, par-out structure, with a zero coupon and zero yield. It was marketed on the basis of a zero to 0.5% coupon. There are also call and put options in year three at par.
The conversion premium was marketed at a 27.5% to 32.5% premium to stock's close on Thursday in New York and was priced at the most aggressive end. At first sight, a 32.5% premium seems extremely aggressive in the context of a stock that has effectively tripled from its $11 IPO price in mid-May.
However, the convertible will be quite dilutive (roughly 8%) and the stock fell sharply over the course of the one-day bookbuild between Wednesday and Thursday's close. Having hit a year-to-date high of $34.56 on Wednesday, it fell almost 13.5% to close at $29.96 on Thursday.
At this level the stock is trading at about 25 to 27 times 2005 earnings on a P/E basis.
Underlying assumptions comprise a bond floor of 78.6%, implied volatility of 50% and theoretical value of par. This is based on a 500bp credit spread, zero dividend yield, 250bp borrow cost and 50% volatility assumption.
Unlike most Taiwanese deals there was absolutely no credit bid and accounts are consequently said to have used a number of different assumptions in their models. If a 600bp spread assumption is used, for example, the bond floor drops to 76.1%.
Likewise, accounts are said to have used a number of different volatility assumptions. With a volatility assumption of 60%, theoretical value comes out at 104%.
The company's traded call options due March 2005 are said to trade at volatility of 69% to 71% on the bid side, while the stock's100-day volatility stands at 78.6%.
The low bond floor is a reflection of investors' willingness to pay up for the equity option in order to extract the volatility. And as one specialist explains, "The lack of credit protection doesn't matter so much for a deal like this, because it has a high degree of equity sensitivity. Investors can get pretty well hedged if they're able to short sell the stock since the deal has an equity delta of 70%. Their residual exposure is only 30%."
With the lack of a credit bid, there is said to have been almost no interest from fixed income investors, although the company runs a net cash balance sheet. Instead the deal appealed heavily to CB arbitrage funds as well as some outright CB funds and equity funds that had previously purchased the IPO.
The scrubbed order book is said to have closed five times covered, with participation by about 100 accounts, of which 75% came from the US and 25% Asia.
Terms look very reasonable relative to other deals from the sector. The three Chinese portals, for example, have all accessed the CB market though in much smaller amounts. Sina led the way in July 2003 with a $100 million deal via Credit Suisse First Boston.
This deal had extremely aggressive terms and a much longer 20-year structure. With a similar par-in, par-out structure to Shanda, Sina's zero coupon, zero yield transaction had a call option in 2012 and a put option from 2007 to 2013 and then again at 2018.
Underlying assumptions comprised an extremely low bond floor of 62.68%, implied volatility of 61.37% and theoretical value of 99.39%. This was based on a credit spread of 1,000bp over Libor, zero dividend, 225bp stock borrow and 60% volatility assumption.
Shanda has said that it is likely to use some of the proceeds from its new deal to buy-back shares from SB Asia Infrastructure Fund, a private equity fund affiliated to Softbank. The group held 17.4% of Shanda post IPO.
Shanda's pricing co-incided with the pricing of an increased $80.6 million IPO for China Finance Online, a provider of financial data and research. The 6.2 million ADR deal was initially marketed at $10 to $12 per unit, but increased to $13 per unit after books are said to have closed more than 10 times covered.
Well over 300 investors are said to have participated in the JPMorgan-led deal. Geographically, the book is said to have split about 70% US, 15% Asia and 15% Europe.
Pricing at $13 per unit represents a 2005 P/E ratio of about 21 times earnings. This places the group at a significant discount to other Chinese e-commerce plays such as 51Job, now trading in the high 30's after pricing in the low 20's at the time of its IPO in late September.
However, investors hoping China Finance would pop in the same way that 51Job did once it started trading, went away empty handed. After opening strongly on its first day trading (Friday) at $15.50, the stock then dipped below IPO price to close at $11.70. The Nasdaq index ended the day up 0.5%.
Yet while the company and its lead manager may have been disappointed by first day's trading, they are likely to feel their decision to set the original IPO range at a reasonable level was vindicated.
As one observer comments, "The important thing is to price each of these e-commerce IPO's where they have fair value and not get sucked into what may turn out to be short-term hype."
During roadshows investors main concerns are said to have centred on the attainability of the company's profit forecasts and potentially low barriers to entry. Specialists say the company showed accounts that while potential competitors could offer stock quotes and other financial information, creating sophisticated research tools would be a lot more difficult.
"This company offers client the ability to model the volatility and trading performance of a large number of stocks all at once," says one specialist. "Im not sure whether it's even possible to do this on Bloomberg."
China Finance operates website www.jrj.com.cn, an abbreviation of jin rong jie, which means financial industry in Chinese. At the end of 2003, the company booked $1.19 million in net profit, a figure forecast to rise to $4..8 million at the end of 2004 and $13 million by the end of 2005.
