China Nickel launches CB exchange offer

The manufacturer of nickel and stainless steel products is offering to exchange outstanding convertible bonds with a redemption value of about $225 million into a combination of high-yield bonds, new CBs and cash.
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China Nickel Resources operates two production mills in Zhengzhou, Henan Province 
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<div style="text-align: left;"> China Nickel Resources operates two production mills in Zhengzhou, Henan Province </div>

Hong Kong-listed China Nickel Resources has made an offer to the holders of its outstanding convertible bonds to exchange them into a combination of new CBs and high-yield bonds as it seeks to make its upcoming cash payments more manageable.

The outstanding bonds mature in December and were issued as part of another exchange offer in the fourth quarter of 2010, just before the put option on the company’s original CB that was issued in 2007 came due. They have an outstanding principal amount of approximately HK$1.33 billion ($172 million) and a redemption value of $225 million.

A one-off payment of that size would be a major challenge for the company, which has a market cap of just over $170 million and at the end of 2011 had less than $20 million of cash and cash equivalents on hand. And since the bonds are well out of the money — the conversion price is HK$1.08 versus a closing price of HK$0.58 yesterday — there is little chance that they would convert into equity before the maturity date.

The company, which is involved in the manufacturing of nickel, chromium alloy steel and stainless steel products, has had a tough time since the first half of 2008 when the global financial crisis led to a significant drop in nickel prices and it posted sizeable losses both in 2008 and 2009. At the time of the first exchange, which was completed in mid-November 2010, the company was optimistic that signs of a pickup in nickel consumption would prove sustainable and it also forecast an increase in stainless steel demand in 2011.

Revenues did improve by 68.5% last year to Rmb2.59 billion ($410 million) and net profit multiplied to Rmb66.3 million from $1.5 million in 2010. However, the operating environment has remained challenging, nickel prices are still weak, and China Nickel’s share price has fallen 66% from a high of HK$1.70 in November 2010. As a result, the company is in no better position to handle the CB redemption this time around.

To deal with the situation, the company is proposing to exchange the existing CBs for new bonds with a three-year maturity. The bondholders will get the full redemption value of the bonds (plus accrued interest), but instead of getting it all in cash when the CB matures in December, only the difference between the principal value and the redemption value will be paid in cash. In addition, 75% of the principal value will be exchanged into senior secured straight bonds with a 10% coupon, while 25% will be exchanged into a new CB with a 6% coupon and an initial conversion price of HK$0.7834.

A swap of CBs into high-yield bonds is fairly unique in the context of a CB exchange, and a source noted that this is being done to limit the dilution for existing shareholders.

The conversion price represents a 26.5% premium to Tuesday’s closing price of HK$0.62 and a 25% premium to the 20-day volume-weighted average price, but comes with a reset down to a floor of 75% of the initial conversion price in December if China Nickel’s share price is trading consistently below the conversion price at the time.

The company is also asking the CB holders to agree to a series of amendments to the terms on its existing CBs in case not all the existing bonds are exchanged for new ones. The proposed amendments include an extension of the maturity from December 2012 to March 2015, the deletion of the right to convert the bonds into equity, and a lowering of the redemption amount from 131.1699% of the principal value to 100%. As these changes make the existing CBs pretty unattractive to hold, there is a clear incentive for the bondholders to accept the exchange.

The alternative would be to say no both to the exchange and the consent solicitation and face the possibility that the company won’t be able to redeem the bonds in full in December.

The exchange offer, on the other hand, has been structured to make it as attractive as possible for the bondholders. While some CB investors may not like the fact that 75% of the existing CB will be changed into straight bonds, the latter comes with an amortising feature that will see the company redeem the high-yield bonds in quarterly instalments starting from March 2013.

This means the bondholders will start to get their money back reasonably quickly, while the company will get a much more manageable payment schedule that it should be able to cover with the cashflow from its operations, sources said. Under the proposal, the coupon on the new CB will also be reduced to 6%, versus 10% for the existing bonds, the conversion price will be significantly lowered and the maturity will be extended by more than two years to March 2015.

The bondholders will give up part of their equity option (by changing the majority of the CBs into high-yield bonds) but on the other hand, they won’t have to accept a haircut.

In case the share price recovers, there is an issuer call after the first year, subject to a hurdle of 125%. The new CBs will be adjusted for dividends that exceed a 35% payout ratio.

The CB holders have until May 29 to choose whether to accept or decline the offer. However, when the company announced in March that it was in discussion with a financial adviser to restructure its outstanding CB and gave a broad outline of the proposed terms of an exchange, the outstanding CBs traded up to about 102 from 80 to 85 before the announcement, suggesting that the market welcomed the proposal. Investors may be particularly relieved that the company is taking action well ahead of the maturity date — as opposed to last time when the exchange offer came less than two months before the put date.

The outstanding CBs are extremely thinly traded though, and sources said there was no noticeable impact on the price after the exchange proposal was announced on Tuesday evening. The share price fell 6.5% yesterday, but that came on the back of a 5.1% gain on Tuesday.

In order for the exchange proposal to go through, China Nickel’s shareholders need to approve the issue of the new CB (or more specifically the new shares that may have to be issued if the new CB is converted into equity) at an EGM on May 28 and the CB holders need to approve the proposed amendments to the terms of the existing CB at a separate meeting on May 31.

The EGM should be a formality only as only a simple majority is required for the resolution to pass and the company’s chairman and controlling shareholder, Dong Shutong, who owns 60.5% has already said he will vote in favour. Also, CB holders who accept the exchange will automatically also accept the consent solicitation, which gives this proposal a high chance of passing as well. The proposal needs to be approved by bondholders representing 75% of the principal value of the CBs and 66% of the outstanding issue needs to be represented at the meeting.

At the time of the previous exchange in December 2010, China Nickel had about 50 CB holders, but sources estimated that that number may have shrunk to about 30 as many investors have sold the bonds since then.

The initial China Nickel CB in October 2007 had an issue size of HK$2 billion ($256 million) and came with a zero coupon and a 40% conversion premium. At the time of the exchange offer it had approximately HK$1.19 billion left outstanding, which would have required the company to come up with HK$1.4 billion if it had been put back in full.

Instead, China Nickel offered to exchange the old bonds, on a one-for-one basis, for a new CB with the same maturity, but with a 10% coupon, a 5.5% yield-to-maturity and a conversion premium of just 3.4% above the market price at the time of the offer. The new CB also came with a reset on November 21, 2011 down to a floor of 70% and an incentive cash payment of $20 for every $100 in principal amount of the existing bonds that were tendered for the swap – making it a pretty expensive exercise for the company. Especially since the share price has continued to trend lower since then. The company also proposed to remove the put option on the existing bonds.

The 2010 exchange offer was accepted by investors holding 97.85% of the initial CB, leaving less than $4 million of that bond outstanding.

J.P. Morgan is the consent solicitation agent and is also responsible for the exchange offer.

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