Bumi's resourceful exchangeable

Controversial Bakrie group completes one of Asia''s most complicated, innovative and unexpected deals of the year.

Indonesia's Bakrie group returned to the international capital markets yesterday (July 19) with a $200 million exchangeable led by JPMorgan. This marks the second time the group has accessed the dollar market in the last month following a $600 million future flow securitization via Merrill Lynch at the end of June.

Both deals represent an attempt to bring down the group's borrowing costs and increase its operational flexibility. More importantly their successful completion signals investors' willingness to re-enter the darker depths of corporate Indonesia provided the return is high enough.

The exchangeable represents an equity divestment by the Bakrie family via its ultimate holding company Long Haul into its listed entity PT Bumi Resources. The deal is collateralized by about half of the family's current stake in the group and was issued via a Cayman Islands SPV Willow Finance.

The exchangeable probably only became possible once the securitization was completed and has clearly piggybacked on its success. It is truly remarkable on two counts.

Firstly, the Bakrie group ranks as one of Indonesia's most controversial business groups and getting any deal done for it will be viewed as a major step forward in the rehabilitation of Indonesia inc. Secondly, the ownership structure of one of the Bakrie group's two main operating companies remains "fluid" and any investment assumptions underlying the exchangeable could therefore be subject to rapid change.

The Bakrie family, under the auspices of Economic Co-Ordination Minister Aburizal Bakrie, owns 42% of PT Bumi Resources, which is listed on the Jakarta Stock Exchange. In turn, Bumi Resources owns 100% of PT Arutmin, Indonesia's fourth largest coal company and 100% of PT Kaltim Prima Coal (KPC), Indonesia's second largest.

The two operating companies have a long and tortured ownership history.

Back in 2001, Bumi Resources purchased 80% of PT Arutmin from BHP Billiton for $149 million. It already owned the remaining 20%. Then in 2003 it paid $500 million for the entire share capital of KPC from BP and Rio Tinto.

In both instances the acquisitions were propelled by outstanding agreements (signed almost 20 years previously) whereby the existing foreign owners had agreed to divest 51% of their respective companies to local Indonesian investors. However, the exact timetable, price and nature of those divestments had long been subject to controversy and litigation.

In the end, both foreign groups decided to wash their hands of the problem and leave Bumi Resources to deal with it instead. And despite the fact that the acquirer (Bumi) was an Indonesian company, the future ownership of KPC in particular continued to remain the subject of intense debate. This is because Bumi purchased KPC through two entities - Sangatta Holdings and Kalimantan Coal - that had foreign investment status.

As such, the East Kutai government, where KPC's mine is located, laid claim to the company itself under the 51% divestment rule. In August last year, Bumi came to an agreement with the local government to sell it an 18.6% stake for $104 million.

However, the government has had difficulties coming up with the funds. Plans to pay for the stake by on-selling part of it before the government had technically bought it were blocked by the central government, as were plans to secure foreign loan funding.

Analysts say the sale and purchase agreement expired at the end of June and it is still by no means clear whether the East Kutai government has now paid for the stake and if not, whether the central government will make Bumi re-tender the shares, or let it keep them and at what price. Some analysts, for example, believe Bumi has an option to re-purchase 10.6%, ceding the East Kutai government the remaining 8% for free.

The remaining 32.4% stake that needed to be sold under the 51% rule is also subject to uncertainty. At the end of June, the Ministry of Energy and Mineral Resources said Bumi had come to an agreement with mining services company PT Sitrade Nusaglobus to sell the stake for $470.5 million. But again, it is by no means clear how long PT Sitrade Nusaglobus has to come up with the cash and what will happen to the stake if it is unable to.

Once these two issues are cleared up, analysts say Bumi has to turn its attention to Arutmin, in which it has to sell a 20% stake. Either way it remains unclear whether Bumi will retain majority control of its operating subsidiaries and what percentage of net profits it will be able to dividend up.

Moreover, its initial purchase of the two companies was extremely controversial and may yet serve to remind investors of the high level of country risk they should take into consideration where Indonesian investments are concerned.

In the case of Arutmin, the Bakrie group was alleged to have sourced funds from government pension fund Jamsostek, using money that was being held on deposit by Bank Mandiri. Where KPC was concerned, few analysts could understand how Bakrie had been able to persuade the two foreign owners to sell it 100% of KPC for $500 million, when they had only recently been strenuously pushing the government to buy 51% off them for $419 million.

The new exchangeable represents a bold move by the Bakrie group to remove the last tranche of the high yielding debt on its balance sheet that resulted from these acquisitions. In 2004, it had entered into three loan agreements structured by Credit Suisse First Boston.

Kaltim Prima Coal raised $325 million via an amortising loan due March 2007 that carried a coupon of 4% over Libor. PT Arutmin raised $162.5 million via an amortising deal due March 2007, which carried a coupon of 5% over Libor.

Finally, the family itself raised $99.8 million via an April 2007 loan that carried a coupon of 18% and was heavily collateralized.

Proceeds from the securitization were used to re-pay the KPC and Arutmin loans. With an average life of three-and-a-half years, the future flow deal was secured by coal receivables and has a coupon of 7.134% to yield 350bp over Treasuries.

The securitization was the main pricing benchmark for the exchangeable, which has a five non-put three structure. Proceeds are being used to re-pay the parent level loan, as well as a second $35 million loan from UOB.

Terms comprise an issue and redemption price of par and a coupon of 9%. There is a put option in year three at par and a call option in year two subject to a 140% hurdle.

The deal has been put together using JPMorgan's ROSES (Resettable Onward Starting Exchangeable Securities) structure. This principally allows companies to retain any near-term equity upside since their transactions do not become convertible until a much later date than normal equity-linked structures. In return, investors are ceded a much higher yield.

In this instance, the Willow exchangeable cannot be converted into shares until August 2006. At this point, investors can convert their shares at an 8.5% premium to the stock's average VWAP between June 11 2006 and August 10 2006.

There are also two re-sets in years two and three with 75% floors.

Observers say the traditional underlying assumptions CB investors use to model their valuations are meaningless in this context since Willow is collateralized by shares. As one observer explains. "There's no bond floor or credit spread since the issuer has collateralized the deal with equity and this is what will govern its performance rather than any credit ratios."

This collateral comprises 4.068 million PT Bumi shares worth $350 million, or 175% of the principal of the bonds based on the stock's closing share price between July 4 and July 8. These have been placed into an offshore SPV, under the jurisdiction of an international trustee.

Observers say the collateral equates to a 20% stake in the company or roughly half the family's stake. One of the reasons why the Bakrie family has been keen to swap the loan for the exchangeable is because the former is more heavily collateralized.

"Last time, they needed $300 million worth of shares to achieve $100 million worth of loan funding," says one specialist. "Now they need $350 million worth of shares to secure $200 million from the exchangeable."

Should the share price rise or drop, the company has an option, or will be forced to either top up or top down the number of shares that back the transaction. For example, if the market value of the collateral falls below 165% of the principal amount of the bonds, the company has top it back up to 175% again within three business days. If it fails to do so, this will be considered an event of default.

The transaction is also puttable, if there is a change in control at PT Bumi, if the company is de-listed and if it is suspended for a period of three consecutive business days.

Should the deal be fully converted at the current share price, the family will see its ownership drop by 11%. However, if the share price performs ahead of the conversion period, the reduction will be much less. This is the main reason why the family was keen on the Roses structure.

"They believe the coal cycle has another year to run and they didn't want to sell part of their stake at the current level," the specialist adds.

Why then were investors keen to buy it? Specialists say the order book was highly concentrated with no more than 10 investors. Rival banks have speculated the true number may be no more than five and includes JPMorgan itself.

Either way, the deal was highly targeted and comprises hedge funds and distressed debt investors that either know Indonesia or liked the implicit return.

"Yes investors are giving away one year of equity upside," comments the specialist. "But once this time period has lapsed, what are you left with? An 8.5% two-year out-of-the-money option with two re-sets. There's a lot of value in that.

"Investors got what they wanted," he adds. "Because there's no credit protection they needed a chunky coupon and 9% represents a significant premium to the one attached to the securitization. Secondly, having given away so much of equity upside the exchange premium needed to be low and it was. Thirdly there are two re-sets to balance the effects of a peaking coal cycle."

Specialists argue that investors derived a high level of comfort from the fact that collateral is securely parked offshore. Furthermore, the securitization had a 144a structure that encompassed a high level of financial disclosure, which should benefit the exchangeable as well.

Finally, Bumi Resources is a $1.8 billion market cap company, with average daily traded volume of $4 million to $8 million. This liquidity should provide further re-assurances.

Perhaps most importantly and ironically of all, investors in the exchangeable should derive comfort from the Bakrie's track record. Despite the group's issues with indebtedness, corporate governance and a large number of disgruntled foreign creditors, it has emerged from the financial crisis stronger than ever before.

So too, no-one doubts the attractiveness of the assets it has been able to pick up along the way. Together Arutmin and KPC account for 6.5% of global coal production.

The Bumi group is now the world's third largest coal exporter. At the end of 2004, it produced 37 million tonnes of coal and has projected the figure to increase to between 45 million and 54 million by the end of this year. By 2008, it hopes to be producing 70 million tonnes.

These production increases in tandem with high coal prices are now starting to feed through to the bottom line. First quarter revenues were up 73% year-on-year to Rp3.06 trillion, while net profit was up 416% to Rp446 billion ($45.5 million). Analysts believe the company should be able to throw off significant free cash by the end of the year, which will enable it to reduce leverage and resume dividends.

It is now planning a New York Stock Exchange listing, although this looks unfeasible until the ownership structure is resolved once and for all.

Year-to-date the stock is up 2.5% to trade at Rp820 per share. This represents a 2005 P/E ratio of about six times.

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