Asset swappers love KDIC deal

Underwriters slice and dice exchangeable bond for fixed-income buyers.

The blockbuster $850 million deal from government-owned Korea Deposit Insurance Corp (KDIC) exchangeable into shares of Korea Electric Power Corp (Kepco) proved a hit partly because about 20% of the deal was asset-swapped for pure fixed-income investors, according to fund managers in Hong Kong and London. Bonds can be exchanged into both Kepco domestic shares and American depositary receipts (ADRs).

The deal, which fund managers believe was Asia’s first privatization-cum-convertible bond, was oversubscribed 10 times, although as one fund manager who bought the deal notes, “Many orders were inflated. We put in a bid for 50% more than we wanted in the expectation that our competitors would do the same. That’s typical for a hot deal.”

What made asset swapping so attractive was stripping out the equity component and creating a five-year FRN with a yield of Libor plus 195 basis points. In Treasury terms that would be around 280 bp over, which is a sweet pickup against, for example, the five-year Kepco due 2005, which yields around 200 bp over Treasuries. In addition, fixed-income investors were delivered a company that, although lacking an explicit government guarantee, is widely viewed as benefiting from the State’s support. And for a deal rated BBB by Standard & Poor’s, its yield is far superior to other Korean BBBs, such as the sovereign due 2008 which now trades around Treasuries plus 220 bp. Moody’s Investors Service rates the KDIC bonds Baa2.

Under an asset swap structure, the underwriters typically hold on to the equity component and hedge it, or sell it to equity portfolio managers looking for cheap deals. Lead managers Deutsche Bank and UBS Warburg did not return calls. LG Investment and Securities is the domestic underwriter. They may increase the deal to $1 billion.

The deal was also helped by the high 28% conversion premium. Kepco’s ADR price has fallen sharply, erasing its premium to the local share price; given that KDIC bonds can be exchanged into Kepco ADRs, fund managers say they are getting a bargain.

The bonds’ strike price is W34,560 ($30.92) versus yesterday’s close of W27,000, and should the share price rise above 35% of the strike, KDIC can redeem them in three years’ time. The bonds pay a semi-annual coupon of 2.25%, which made fund managers happy, given expectations of a coupon at 2.50%.

Demand likely from UK, US

While asset swappers in Asia and Australia are happy with the deal, fund managers and analysts expect most demand to have come from London and New York. UK insurance companies are said to be the most likely target for this kind of deal because they like the yield protection. Many corporate pension funds, on the other hand, are prevented from investing in emerging market convertible securities. Furthermore, institutions in London and New York are very familiar with Kepco.

Perhaps most important, the success of KDIC could set a precedent for a revival of Asian convertible bond issuance. Fund managers believe a range of quasi-sovereign borrowers in China and Korea, led by China Mobile, are keen to issue convertible instruments. The success of KDIC could restore interest in these deals particularly among Asian investors. Asian convertible bonds have a chequered history in this region; most were issued in the boom years of 1993-94 and subsequently their buyers got burned when they converted during the Asian crisis. Furthermore these early issues, having now expired, leave corporates hungry for more capital. Last: the governments badly need to privatize and convertible instruments may prove an easier sell than straight equity.

The biggest obstacle won’t be conditions in Asia, fund managers believe. Rather, it will be European issuance, which is exploding. Nonetheless, fund managers are pleased to see a success from the region, especially given the scarcity of new issues this year.

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