Asia Aluminum has announced plans to launch a tender offer for all its outstanding international bonds as part of a restructuring that it says is needed to pull it out of a situation of deteriorating earnings and cash flow, rising costs and an increasing debt burden.
The Chinese aluminium producer has run into difficulties partly because of the deep downturn in the aluminium extrusion industry which has seen sharp falls in demand and selling prices, as well as the decline in global economic conditions and the tightening of credit. There has also been a delay in the commissioning of its new flat-rolled products manufacturing facility and thus in the revenue flow that it was meant to bring. But the group also aggressively increased its debt levels as part of a leveraged buyout by its majority shareholder and chairman, Kwong Wui-chun, in May 2006, and in the current environment is finding it increasingly difficult to service this debt.
The privatisation was financed through the issuance of $535 million worth of six-year Payment in Kind (PIK) notes by AA Investments Company (the buyout entity), which for the first three years pay the coupons in the form of new note issuance. This has meant that the original principal, which was split on $355 million of 12% notes and $180 million of 14% notes, has increased to $727.5 million since issuance. AAI, which gets its revenues solely from 100%-owned Asia Aluminum, needs to start paying the semi-annual coupons in cash from November 2009.
In addition to this, Asia Aluminum also has $450 million of outstanding 8% high-yield bonds, which were issued in December 2004 and mature in 2011. As of December 31, 2008, AAI's total borrowings (including bank loans) amounted to HK$14.09 billion ($1.8 billion), which compares with a consolidated Ebitda of HK$1.1 billion in the fiscal year to June 2008.
Realising that it is running out of time, the company's solution to this debt problem is to ask the bondholders to take a significant haircut and accept a buy-back well below face value, but at a slight premium to where the bonds were trading before the offer. The tender will be accompanied by a consent solicitation to amend certain provisions under which the bonds and PIK notes were issued.
Underlining the seriousness of the situation, the company said in a press release on Friday that if the tender offer fails, its bank creditors may demand immediate repayment of all outstanding amounts and refuse to approve further drawdowns under its existing working capital facilities. A failure to buy back the bonds may also hamper separate attempts by the chairman to restructure the remaining borrowings and to secure additional working capital. The chairman has received letters of intent from two of the company's existing Chinese bank creditors, saying they are prepared to provide up to Rmb6 billion ($879 million) of additional funding to allow the company to refinance its outstanding debt and cover its working capital needs -- providing that it first successfully completes the tender and satisfies certain other conditions.
"Completion of the tender offer and consent solicitation is crucial to our restructuring efforts and accordingly, our ability to continue as an operating company," Asia Aluminum said.
A source close to the company argues that this makes Asia Aluminum's tender offer different from Galaxy Entertainment's bond tender in December and the buy-back offer by Nine Dragons Paper that is currently underway. Both of those, he says, are opportunistic attempts to take advantage of the current low bond prices, while Asia Aluminum's offer is a much needed debt restructuring exercise. The difference is partly evidenced by the fact that Galaxy and Nine Dragons have much more reasonable debt levels of about six to seven times Ebitda.
Under the terms announced Friday, Asia Aluminum will pay 27.5 cents per dollar for the $450 million of bonds, which compares with a bid in the low 20s before the offer became known. Market participants said the bid-offer spread increased to 27/32 on Friday after the press release was published. The holders of the PIK notes, which have 1.7 million warrants attached, will be offered 13.5 cents to the dollar. Galaxy and Nine Dragons both offered 53 cents to the dollar for their bonds.
To be sure, Asia Aluminum may have ended up in trouble even without the LBO as the delay of its expansion project, which aside from the large-scale production line for high-end flat-rolled products, has also more than doubled its aluminium extrusion capacity, has hampered its earnings ability at a time when outside funding has dried up. Earlier this month, Indalex Holdings, the second largest producer of soft alloy aluminium extrusion products in North America and a former partner of Asia Aluminium's, entered a 30-day standstill with respect to the payment of interest on its outstanding bonds to give it time to evaluate alternatives for reducing its overall debt levels.
But like many companies taken private over the past couple of years, the high level of debt is adding additional pressure in the current environment. Last Thursday Aleris International, a TPG-sponsored global leader in aluminium rolled products, extrusions and recycling, filed for Chapter 11 for its US operations, citing financial constraints related to deteriorating demand, earnings, and liquidity caused by the steep decline in global economic conditions. Aleris said this was the only "meaningful" option to preserve value for all of its constituents. TPG acquired Aleris in 2006 in a $3.3 billion deal.
Asia Aluminum's tender will be funded with the support of a Chinese municipal government, which in return will receive a 25% equity stake in the AAI. Chairman Kwong currently holds 97.4% of AAI, but will see his stake being reduced to 30% once the restructuring is completed as he will also transfer 28.4% to an escrow account for the benefit of the management and other employees and for a potential future sale to one or more equity investors; and a further 14% to a three-member consortium led by ORIX Corp in exchange for its 25% interest in one of the group's subsidiaries.
Before he took the company private in 2006, the chairman owned 63.8% of Asia Aluminum, and the fact that he will end up controlling less than half of that following the proposed restructuring underscores the failure of the privatisation. In hindsight, the company was convinced to take on far too much debt and even if the chairman may be forgiven for not envisaging the extent of the global economic downturn, this was one of the most aggressive LBOs in Asia in recent years and a trade that people now say was only ever going to work in a bull market.
The $500 million plus financing of the privatisation resulted in the company's existing debt-to-Ebitda ratio of seven times increase to 13.3 times, which prompted Merrill Lynch -- the financial adviser to Kwong -- to call it "the first true leveraged financing transaction in Asia". At the time, the company had a market cap of only $350 million.
Based on its earnings in the 12 months to June last year, Asia Aluminum currently has a debt-to-Ebitda ratio of 12.8 times, but in the press release it said that its Ebitda had declined "significantly" in the six months to December 31 due to a 20% year-on-year drop in sales volumes and a 29% rise in its cost of sales per tonne. Its overall cost structure also increased significantly as it continued to prepare for its new plant to start production, while at the same time the tighter lending policies at the banks has meant that it has been unable to access external sources for working capital, but has been forced to rely on its own deteriorating cash generation.
"We expect our Ebitda will continue to decline unless market conditions improve significantly; we are able to access sufficient working capital; and we are able to commence commercial production at our aluminium rolled products expansion project," the company said.
It remains to be seen whether investors will accept the offer, but the fact that the bid price edged up to just under the tender offer price once it became known suggests that someone in the market at least expects it to go through and is trying to make some money on the arbitrage. Observers note that the fact that there are several groups of bondholders divided between the bonds and the two sets of PIK notes makes it a complicated tender. However, if the alternative is bankruptcy followed by an onshore debt restructuring -- the outcome of which would be highly uncertain -- they may bite the bullet and prefer to cut their losses.
There is no investment bank involved in the tender offer, but Asia Aluminum is taking advice from a financial advisory agent.