Roadshows began in Hong Kong on Friday for one of the most exciting new Asian credits to tap the international bond markets. With Credit Suisse First Boston and Merrill Lynch as lead managers, China National Offshore Oil Corp (CNOOC) has set out to raise $500 million from a 10-year 144a bond offering that will price between Thursday this week and Monday next week, subject to how quickly demand gets out of hand.
Market participants universally agree that the transaction is one in which all investors will want to participate, unless indicative pricing levels get so tight that international investors drop away.
Success will hinge on two key factors.
Firstly and most importantly, there is the traditional conundrum of how to balance US and Asian pricing expectations. In China's case, the problem is particularly acute because the onshore bid is so huge. Secondly, both the leads and investor base are faced with the added difficulty of assigning value to a deal whose "official" credit ratings appear to have little bearing on the company's true worth.
These two issues, in tandem with the transaction's rarity value and limited new supply from both China and Asia, have led many to conclude that pricing is more likely to surprise on the tight side than wide side. Preliminary price guidance has yet to be put out in the market, but there are those who anticipate pricing as tight as 150bp to 160bp over Treasuries. Others believe that it may end up being closer to the 170bp to 180bp mark.
At the heart of the issue is the company's Baa2/BBB rating, which some believe says more about a confused and controversial stance towards China sovereign risk by the rating agencies than CNOOC's credit fundamentals. On a stand-alone basis, the company's supporters argue that its clean balance sheet and dollar revenue base make it an unquestionably straight single-A credit.
In other parts of the world, exploration and production companies (E&P) like CNOOC have pierced the sovereign ceiling because their dollar revenue bases are felt to mitigate sovereign default risk. In Asia, for example, Malaysia's Petronas has a one notch higher rating than the sovereign from Moody's, while Indonesia's PT Medco Energi has a four notch higher rating from Standard & Poor's.
In Standard & Poor's case, the agency has always held a contrary view of China's sovereign strengths relative to Moody's and rates the People's Republic BBB against Moody's A3 level. In assigning CNOOC a BBB rating it, therefore, appears to have discounted the company's stand-alone strengths and penalised it for its 70.6% state ownership.
Moody's, by contrast, rates the sovereign at a higher level, but has historically maintained the view that state-owned companies should be rated two notches lower than the sovereign because the state will re-pay its own direct obligations ahead of those in corporate sector. The one exception to the rule has been the China Development Bank, which has a Baa1 rating and is viewed as a sovereign proxy.
However, some bankers point out that although CNOOC is likely to be disappointed with its rating, its officials can take some comfort from Moody's assignment of a positive outlook, which makes the company China's highest rated corporate credit.
Ironically, the China factor will almost certainly prove to be one of deal's greatest selling points when it comes to pricing. Strong domestic appetite for dollar paper has always been a given, leaving discussion to centre on the effect of potential future supply. The leads are likely to argue that CNOOC should be accorded a pricing benefit, both because it plans to create a liquid yield curve through repeat issuance and will not be weighed down by competing supply, since most Chinese corporates do not have a dollar revenue base to support international bond issuance.
The difficulties of hedging the RMB mean that there has always been a greater promise of supply from China than actuality. Lead managers may, therefore, argue that while Sinopec and Petrochina are waiting in the wings, neither will have substantial overseas borrowing programmes because of their largely domestic revenue bases and strong relationships within the Mainland's banking system.
For those who believe that geography will be the key pricing determinant, the two main benchmarks are: the Sovereign's 6.8% May 2011 issue, which is trading at 101bp/92bp over Treasuries to yield 5.8%/5.7% and the China Development Bank's 8.25% May 2009 issue, which is trading at 102bp/89bp over Treasuries, to yield 5.8% bid.
On a like-for-like basis, CDB is trading about 30bp wide of the sovereign. Having taken the need for a new issue premium into account, the question then comes down to how wide CNOOC should trade relative to CDB. Or conversely, should CNOOC's forward-thinking management abilities, transparent corporate governance and clean balance sheet count for more than state ownership of a banking system where none of the above could currently be said to apply?
Unlikely virtually all other state-owned enterprises, CNOOC has never relied on government funding and operates on a stand-alone basis. What it does receive, on the other hand, is a hidden subsidy in the form of its revenue sharing agreements with foreign oil companies. A regulatory policy, which currently allows it to take 51% of all E&P revenue generated by foreign operators, has fostered profitability and creditworthiness in a very young company and enabled it to build up a balanced portfolio, of which revenue from the foreign operators has now declined to 50% and revenue from its own E&P activities grown to 50%.
In terms of the company's debt ratios, CNOOC currently has a debt to capitalization ratio of 13.5% and operates an EBITDA to interest coverage ratio of 45 times 2002 earnings. As at the end of 2001, it had $2.1 billion in cash on its balance sheet and $542 million in debt, of which 70% was denominated in dollars, 25% in yen and the 5% in RMB. Average maturity stands at three years.
Prior to the company's re-organisation ahead of its IPO in January 2000, however, it operated much weaker ratios and both rating agencies have commented that gearing will increase as the company funds its capex plans ($4.7 billion from 2001 to 2003) and if oil prices should fall. Because CNOOC has no downstream operations, it has less of a buffer in a declining price environment, although an extremely low lifting cost (the ultimate oil industry efficiency measure) of $3.18 per barrel over the last three years has enabled it to maintain an efficient cost structure.
Back in 1998, CNOOC operated a debt to captialization ratio of 61% and going forwards the company expects to hit the mid 30% level. But, investors have been given additional comfort that the company will continue to maintain a conservative financial policy as the new bond issue has covenants stating that its secured liabilities will not exceed 50% of adjusted consolidated net worth ($1.9 billion based on June 2001 figures).
Away from China other sector benchmarks can be derived from Petronas and LG Caltex. The former has a one notch higher rating from Moody's (Baa1), but its spreads are weakened by the lack of an onshore bid and investors' perceptions of sovereign credit risk. Its August 2015 bond, for example, is currently trading on a bid/offer spread of 245bp/232bp to yield 7.27% bid.
LG Caltex of Korea, which has a split Baa2/BBB- rating stands one notch lower than CNOOC from Standard & Poors. Like China, there is always a strong onshore bid from Korea and the company's 2011 dated issue is currently trading on a bid/offer spread of 205bp/190bp to yield 6.92% bid.
Further afield, observers say one of the key benchmarks will be Andarko of the US, which has a Baa1/BBB+ rating and a 2011 issue trading on a Treasury spread of 140bp bid. US investors have always traditionally demanded an Asia premium and over the past year been shut out of many Asian primary deals, which tend to trade flat or through US comparables.
Where CNOOC's issue is concerned, some observers argue that it may benefit from the "Enron effect." As one puts it, "There's been a lot of volatility in US corporate spreads recently and for the first time US investors may actually view Asia as a safe haven."
Should CNOOC price at the tightest end of expectations, it will also achieve the rare feat of coming through most of corporate Hong Kong (despite its rating). Although the state-owned train operators are both trading at just under 100bp over Treasuries, pure corporate issuers are up to 100bp wider.
At one end of the scale, Hongkong Land, which has an A-/A3 rating, is trading at 157bp bid on a May 2011 issue, while A3/A rated Hutchison Whampoa has a 2011 bond bid at 160bp over. Those with high triple-B ratings only just break the 200bp barrier, however, with Baa1/BBB+ rated Hysan Development at 195bp over on a 2011 issue.