Brilliance China sells new convertibles to refinance unbrilliant CB

Company is bullish on turnaround story, but downside protection features needed to compensate for desired high premium.
Hong Kong-listed Brilliance China Automotive Holdings last night raised $182.68 million from the sale of convertible bonds that got the bookrunner working for its money.

The mainland car maker, which has been under pressure over the past year because of oversupply in the industry and a margin squeeze caused by rising steel prices, needed cash to be able to refinance an outstanding $200 million CB that is deeply out of the money and is likely to be put back to the company in November.

But rather than playing it safe and going for a low conversion premium to ensure success, the management wanted to make the most of its bullish views about the companyÆs growth prospects.

Consequently it went out with an aggressive conversion premium range of 36% to 45% over last ThursdayÆs close of HK$1.42, which not surprisingly ended up being fixed at the low end for a conversion price of HK$1.93. (The Hong Kong market was closed for a holiday on Friday and the stock was suspended yesterday)

The conversion premium record for a Hong Kong-listed company is 50%, which was pulled off by tissue paper manufacturer Hengan International Group on a HK$1.5 billion bond issue in mid-April. Before that the record was 40%.

However, even at the 36% level Brilliance ChinaÆs bonds required a few additional features to protect investors on the downside, including an aggressive double conversion price reset.

Citigroup Global Markets as the sole arranger was able to sew it all together, and in the end around 35 investors participated. The deal was said to have been ôcomfortably coveredö and ôfully placedö which typically means it was between one and two times subscribed.

Allocations were skewed towards Asia, but with healthy demand from both Europe and offshore US accounts. The bonds werenÆt offered to US-based investors.

The key selling argument was to look at Brilliance China as a turnaround story and some investors were said to have spent a lot more time than is common for a CB issue to try and understand where the cash is going to come from and what the companyÆs credit profile looks like. As usual though, the final decision on whether to participate or not was down to pricing, and here the company did cut investors some slack.

ôThe company has a very bullish view on the turnaround story, but it was willing to pay for it with a higher yieldàand as it turned out, the market could just deliver (what it was looking for in terms of premiums),ö one observer says.

The zero-coupon bonds have a five-year maturity, but investors can put them back to the issuer after three years at 122.9% of face value for a yield to put of 7%. The bonds were marketed to investors with a yield range of 6.5-7%.

The deal was launched at a base size of $180 million but with an option to increase it by up to $30 million. The final size was determined by a desire to issue the maximum amount of new shares without exceeding the 20% regulatory limit in any given year.

They were issued at par and will redeem at 141.06%, also for a 7% yield. There is a call after two years subject to a 145% hurdle, which after the third anniversary falls to 130%.

If the share price fails to reach the initial conversion price, the latter will be reset at the prevailing market price after nine months, although not below a HK$1.31 floor which is equal to 68% of the initial conversion price. There is a second reset after 21 month, also at market price, although not lower than 75% of the first reset price.

Given that there is no credit bid, assumptions on the credit spread vary widely between 600 basis points and 1,000 basis points over Libor, but if the mid-point is used it gives a bond floor of about 83%. The implied volatility came out ranging from 24% to 28% depending on how the reset mechanism is valued, but either way looks quite attractive versus a 100-day historic volatility of 52% and or even a 260-day volatility of 41%.

The bonds have full dividend protection for investors and assumed a 5% stock borrow cost as there is very little borrow available, even though it is theoretically possible to sell the stock short.

The share price is up a modest 3.6% over the past 12 months, but has been quite volatile this year with a first peak at HK$1.57 in early February, which was followed by a slump to the HK$1.12-1.13 area and then a second peak at HK$1.55 on April 11. The share price jumped 21.1% on April 11 alone when JPMorgan published a positive report on the company that helped increase investor confidence in the stock.

In the report the US investment bank argued that the ôworst is overö for the red-chip company and projected earnings growth of 67% in 2007 and 26% in 2008 following a turnaround in 2006. The earnings improvement will be driven by higher-than-previously-expected sales of minivans, Zhonghua sedans and BMW cars in 2006 and 2007. The bank also upgraded the stock to outperform from underperform based on an assumption that news related to its weak operations in 2005 is now fully priced in, as well as the success of new models and a commitment by the new management to put the company back in order.

Two weeks ago, Brilliance China reported a loss of Rmb649.6 million for 2005 due to production overcapacity in the industry and intensifying price competition. It added though that the recovery of the automobile industry in China ôappears to have gained momentum in the first quarter of 2006ö and said the company has taken ôinternal measures to improve its operating efficiency and competitiveness by broadening its product range in both minibuses and sedans.ö
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