China Development fails to re-energise CB market

A $450 million convertible for the Taiwanese financial holding company just clears the market raising questions about the fate of others still waiting in the pipeline.

In response to its many critics, lead manager Goldman Sachs appeared to have fully syndicated China Development Financial Holding's (CDFH) deal on Friday in the face of a market showing very clear signs of indigestion. However, none would deny that the deal was anything but a struggle from start to finish and many now wonder where the next issue for either SinoPac or Chinatrust can go from here.

Since Fubon's $430 million deal of early April, a total of $1.58 billion has been raised by the top three holding companies by market capitalization and there is still at least $1.2 billion more to come. Goldman consequently attempted to structure a deal for China Development, which it hoped would address the needs of the issuer and investor base in a difficult market.

Where the former was concerned, the adoption of a one-year puttable structure continues to prove controversial among most market participants because of the re-financing risk. In China Development's case, this is less of an issue than it would be for a tech company, because it has continual access to the interbank market and is carrying surplus capital at the subsidiary level, which can be dividened up in the event that the interbank market is closed.

For investors, the structure is highly defensive, offering the highest bond floor of the year to date and an extremely cheap equity option. Underlying this is a credit, which is the tightest bid of any in the Taiwanese universe and an equity story, which has delivered consistent growth for the past few days despite the volatility of the wider equity market.

It should have blown out, but it didn't and as one market participant aptly summarises, "Timing and sentiment are all important in the convertible market as investors can often be a fickle bunch. Globally, they're in subdued mood at the moment, although Asian convertibles are still performing relatively well and in recent weeks returns have been propped up by a string of very cheap deals from Japan.

"But," he adds, "Many accounts are actively pulling back. Volatility is falling and there's limited demand from convertible arbitrage accounts, which haven't been doing that well at all. Where Asia is concerned, there's also only a finite amount of paper investors will pick up from issuers which do not offer the ability to short sell."

Market fundamentals aside, most of the competition also argue that the presence of Goldman Sachs as lead manager did not get the deal off to a good start. As a second convertible specialist comments, "Goldman is a great equities house, but it's fact of life that sometimes you're the house to be and sometimes you're not. Clearly because the recent Cathay Life was so exceptionally aggressive and has cast a long shadow over the market, Goldman is not flavour of the month with investors at the moment.

"Accounts remain convinced that the lead still holds a very long position in Cathay paper and going into the China Development deal they would naturally question how this would impact Goldman's ability to manage the grey market and support secondary trading," he continues. "Therefore, the momentum was never there from the outset."

The lead on the other hand has been maintaining that it has no exposure to Cathay and interdealer brokers further report that as the China Development deal broke syndicate on Friday afternoon, Goldman was actively in the market trying to push the deal back to par, albeit at the expense of seeing its bid continually hit by the rest of the street. Throughout the course of the nearly two-day bookbuild, the deal had traded down in a range 99.125% to 99.50%, but inched back up to 99.875% just before pricing as it became clear that it would clear and it stayed around this level in the few hours of Asian trading after the deal was closed.

Final terms comprise a December 2004 maturity, with a zero coupon, zero yield and 22.661% conversion premium to the day's volume weighted average. The stock closed Friday at an NT$22.9 level, up 1.75% on the day. The deal also has a one-year put option at par and a downward re-set that falls 15 days before the put option and has an 85% floor. The greenshoe stands at $125 million, increased from $90 million at the announcement of the deal. On full conversion, the deal adds 7.07% to the pre-deal issued share capital.

Underlying assumptions comprise a bond floor of 96.4% and implied volatility of 22.9% if the re-set is fully valued and 27% if it is not. This is based on a credit spread of 110bp over Libor, 4.5% stock borrow cost and zero dividend yield (there are full anti dilution provisions).

Books were said to have closed covered, with a geographical split of 38% Europe, 27% Asia, 15% US and 20% offshore entities.

Because Taiwanese bank demand for China Development's credit was so strong, the asset swap bid was said to have come in from a 120bp to 125bp level at the time when the deal was announced to a 105bp to 110bp level as it closed. With a BBB+ rating, China Development stands alongside Cathay Financial as the highest rated in the Taiwanese convertible universe and during investor marketing the lead emphasized the group's high capitalization (41.7%) and reasonable ROE (9%).

Marketing of the equity story highlighted consistent returns despite the tech boom and bust, which has rocked the Taiwanese stock exchange over the past two years. As a venture capital investment company, China Development has a high 70% correlation to the TWSE, but has delivered CAGR of 23% between 1996 and 2001 as well as increased its long-term portfolio by 27% over the same period.

"This shows that China Development has re-invested its gains in addition to realising them through retained earnings," one specialist comments.

Nevertheless, a number of convertible specialists question where the potential upside for outright accounts lies. The conversion premium is the highest from Taiwan this year and what is effectively a one-year maturity does not give the deal much time to perform.

"The chances are that investors will get their money back," concludes one participant. "This deal requires a lot of share price performance from a sector which isn't considered high growth. Had the conversion premium been a shade lower, demand might have been a lot stronger."

But on balance did China Development make the right decision in coming to the market now? Most would probably concede that it did. It's deal may not have been a huge success, but the bank did at least raise the funds it wanted where others may have to wait. And while it did not achieve long term funding it did manage to replace existing short term debt with zero cost short term debt and in the process disersify it's investor base.