All convertibles come down to credit, but the problem with Chartered seems to be that there is no spread consensus at all, with industry experts arguing for ranges veering from 175bp over Libor to over a 300bp level. Comparables are few and far between and at the heart of the issue lies the fact that while the company is located and ultimately majority-owned by AAA/AA1-rated Singapore, it is operating a capital-intensive business, in which inventory build-up and slowing global demand has seen the sector's stock prices decimated by global equity investors.
Where most agree, is that any credit assumption hinges on the value investors assign to the foundry manufacturer's Singaporean parentage, the halo effect as one commentator puts it. Previous international bond issues from government-owned Singapore Power, Port Authority of Singapore and the partially-owned Development Bank of Singapore, have all commanded extremely tight levels, driven by their high credit ratings and novelty value on the global fixed income stage.
Chartered Semi itself provides one recent domestic comparable with an $820 million six-year syndicated facility for one of its joint venture operations, Chartered Silicon Partners. This was completed last September on a non-recourse basis at about 100bp all-in, according to bankers. Referenced against this deal, the 200bp to 225bp credit spread assumption for the convertible being marketed by lead manager Merrill Lynch would seem to err on the generous side.
Bankers who believe that the credit spread is not tight enough, argue that the deal's rarity value for international and domestic investors, combined with the latter's lack of credit sensitivity are the two main factors driving an order book which closed its first day in Asia three times oversubscribed.
As one observer puts it, "This deal is dirt cheap. There will be incredibly strong local demand for the credit, which is viewed in a completely different domestic light to what the balance sheet might imply on a standalone basis. The transaction will, therefore, be predominantly sold to European and offshore hedge funds that will strip the deal and sell the credit portion back to Singapore."
Others, however, argue that domestic demand will be insufficient to comfortably underpin the transaction and that international investors will demand some form of premium for the risk element attached to the volatility of the semiconductor business. As one credit analyst puts it, "International investors will be looking at the asset swap levels of industry peers TSMC and UMC, which are both larger and stronger companies. TSMC has a theoretical asset swap level of 200bp over Libor and Chartered has to come at least 50bp to 75bp behind this."
A second adds, "Chartered may look like it has government ownership, but it is actually three steps removed through Temasek and Singapore Technologies. Singapore is a privatization-driven society now, where the government is trying to encourage professional, hands-off ownership and management. This is a company whose credit fundamentals will also deteriorate over the short term as capex increases and the balance sheet is geared up."
On this basis, some bankers suggest that, were the company to apply for a credit rating, it might not even achieve an investment grade level. This contingent consequently argue that the deal is being mis-priced on a number of levels and would already be significantly more oversubscribed were it to incorporate a wider credit spread, lower bond floor and higher implied volatility.
Merrill Lynch's assumptions
In getting to the stage where it was able to launch the offering without the aid of a syndicate, Merrill Lynch had to wrench the transaction back off one bank which had already been assigned a working mandate and contend with a small group of others which firmly believed that they were about to be mandated themselves. The selection process was hardly transparent and certainly not conducive to a smooth launch pad in a market environment where every last piece of business is intensely fought for and none more so than from Chartered, whose rise to prominence and future capex spending promises many more deals to come.
For any lead manager, it would also become rapidly apparent that, while Chartered superficially appears to be the ideal candidate for a convertible, one crucial component is missing. Investors and particularly the hedge funds that form of the mainstay of the market, typically want bond floor, equity upside and volatility. Chartered has all three, but unfortunately, extracting value from the volatility is said to be far from easy, especially when the parent company is unwilling to lend stock out itself.
"Chartered may have an ADR outstanding, but there is no stock out there to borrow against it," one banker reports. "The stock borrowing market has completely dried up and any investor that tries to trade the implied volatility is on a hiding to nothing.
"The main problem," he adds, "is that the underlying markets are hugely volatile and moving rapidly on a day-to-day basis. This is a new credit in an extremely volatile sector that has been badly beaten up by investors. No-one knows where to value it properly and there are a lot of moving pieces. This company is not rated, but it is a quasi-sovereign entity. In the local market, it could borrow at much tighter terms, but in the international markets, investors are being very, very cautious."
Lead bankers consequently believe success will be determined by an ability to target outright accounts that believe in the company's fundamental credit story, but want a defensive instrument at a time of high volatility. As a result, the company has opted to explain its credit over a three-day roadshow that began yesterday and will finish on Wednesday when the deal is provisionally scheduled to price.
"Merrill Lynch had a tech conference in Taiwan last week with over 300 participants and therefore has a good idea what sector investors want at the moment," one banker comments. "Investors think that the sector is being driven by inventory build-up and the slowdown of the US economy. But they are still not sure whether there is going to be a V-shaped recovery or a U-shaped one. If it's going to be the former, they don't want to miss out, but in case it's the latter, they don't want to invest in straight equities just yet. They want the kind of downside protection that a convertible best offers."
Terms for the deal incorporate a 2.5% coupon, a conversion premium of 27% to 33%, a yield-to-maturity of 5.6% to 6% and hard no call for two years, thereafter subject to a 125% hurdle. There are no put options. According to the lead, the underlying assumptions comprise a credit spread of 200bp to 225bp over Libor and a bond floor of 92 to 94. At its cheapest, bankers say that fair value comes 10 points wider. Implied volatility is said to lay in the mid 20s.
Critics argue that these terms simply don't make sense because investors will look at implied volatility and most will price it much higher, in the process cheapening the terms since the equity option will be considered more valuable. "We have used an implied volatility of 45% based on a historic 100-day volatility of 81%," says one. "Taking a credit spread just below the 200bp mark, this brings the bond floor on a 93 to 98 range and fair value at 107.87 to 110.82, which is obviously very cheap."
A second adds, "This is a good credit and the implied volatility should be much higher, particularly when sought-after comparables such as China Mobile and Samsung Electronics are trading at implied volatility levels in the high 50s. Which would you choose as an investor? A BBB-rated credit like China Mobile, trading on an implied vol of 50.4%, a premium of 60% and a yield of 3%, or an implied BBB credit like Chartered offering a roughly 30% premium, 5.75% yield and implied vol in the mid 20s? It's not a hard investment decision to make."
How much the equity option should be worth divides participants almost to the same degree as the credit spread. While the lead argues that the lack of stock borrowing makes the concept less relevant, those at the opposite end of the spectrum argue that Chartered should be offering between 15 to 20 points. "Take China Mobile as an example," one banker reiterates. "It presently has a dollar price of 97 and a bond floor of 83, a 14 point differential. We believe that Chartered should have a credit spread of about 300bp over Libor, which brings the bond floor down to about 85 to 86. But even at this level, the deal is too cheap, because implied volatility is still in the high 20 to low 30 range, when it should be in the high 30 to low 40 range. The bond floor should be in the low 80s or even the high 70s."
Others take a different stance again. "We don't think the equity option should be worth more than about 10 points," says one banker. "What we see happening is a marketing process where the lead is trying to convince investors that the credit is better than it is and make the equity option seem cheaper than it really is. Outright investors will be asking themselves whether they believe that the credit spread should be 200bp. If the answer is no, then the bond floor will drop below 90 and the equity option has more value. But does an outright investor with a fixed income bias really want to buy a transaction where it will have to have pay more than 10 points for the equity option? Maybe not."
With specialists determining credit value at anywhere between 175bp to 300bp over Libor, bond floors of between 94 and 77 and implied volatility between the mid 20s to high 40s, indicative terms are wide enough to drive a truck through. Some observers further conclude that the lead is being dished by a severe case of sour grapes and cite the extremely fragile state of the equity markets as reason enough to bring attractive terms.
For Chartered, the company wants to build additional flexibility into its balance sheet as it finishes construction of its sixth wafer fabrication plant at a total cost of $3.5 billion. Having submitted a $4 billion SEC filing, the company is thought keen to bring a deal that works for the market, conscious that there will be more to follow.
Also launching a convertible yesterday, the Taiwanese DRAM manufacturer is hoping to take advantage of a small window that appears to have emerged following indications that PC manufacturers are clearing inventory much quicker than expected. Reports that the backlog has almost been removed by the world's second and third largest chip manufacturers, Micron and Samsung Electronics, has had a positive impact on share prices across the sector. ProMOS closed Monday at NT$38.8 ($1.19), up 31.53% year-to-date.
Terms for the company's Deutsche Bank-led deal comprise a $180 million issue size and $20 million shoe. There is a five-year maturity, zero coupon, conversion premium of 15% to 20% and two-year put at 109.22 to 110.83%, to yield 25bp to 100bp over Treasuries. There is also a two-year call subject to a 135% trigger. Sun-Fund Securities is co-lead manager.
Underlying assumptions comprise a credit spread of roughly 300bp over Libor and implied volatility of 21% to 25%. The company is also said to have chosen a two-year deal rather than the favoured rolling put structure because it wants some security of proceeds.
The deal is scheduled to price on Friday following a roadshow, which began in Hong Kong and moves to Los Angeles today, followed by Boston and New York on Wednesday and London on Thursday.Specialists believe the deal will also go well because of the defensive characteristics of the stock. "ProMOs is 33% owned by Infineon of Germany and 48% by Mosel, with 90% of its output tied to these two major shareholders," says one banker. "Because it has locked-in buyers, the stock has much better upside in an overall market where investors are trying to weather the downside."