China Nickel makes last minute attempt to swap old CBs for new

China Nickel Resources Holdings yesterday made a proposal to the holders of its outstanding zero-coupon convertible bond that matures in December 2012 to swap it for a new issue with the same maturity, but more favourable terms. The purpose of the swap is to avoid having to redeem the existing CB this coming December when a put option is due and consequently the company is also proposing to remove the put option on the existing bonds through a consent solicitation.

The existing CB is trading deeply out of the money, having come to market with a 40% premium back in 2007 when the share price was almost three times as high as it is now. This makes it highly unlikely that it will ever convert into equity and with the company having flagged earlier this year that it would unlikely be able to cover a redemption of the CB this year, the bondholders had been expecting some kind of restructuring.

However, the swap proposal does seem to come quite late, given that there is less than two months left until the put is due, and it has a feeling of “last resort” about it.

Indeed in an announcement filed with the Hong Kong stock exchange yesterday, China Nickel said that it “may be unable to honour its payment obligations under the existing bonds if the put option is exercised in full by the existing bondholders” and if alternative financing isn’t made available to the company before the payment date.

And that in turn would have “an adverse impact on the company’s ability to continue as a going concern”. In short, the company may have to file for bankruptcy if the consent solicitation and the CB exchange proposal aren’t successful.

To ensure that the 50 or so CB holders accept the proposal, the new CB comes with generous terms, including a 10% coupon and a conversion price of HK$1.541, which equals a premium of just 3.4% versus the HK$1.49 close on October 18 -- the last trading day before this announcement. Although, according to sources, the conversion price was derived at by applying a 35% premium to the volume-weighted average price for the 30 days leading up to yesterday’s announcement. While already low, the conversion price may be reset on November 21 next year, down to a floor of 70%.

There will also be a cash payment of $20 for every $100 in principal amount of the existing bonds that is tendered for the swap. The company will issue $100 of new CBs for $100 in principal amount of the existing bonds. The new bonds will mature on the same date as the existing ones, ie on December 12, 2012, and will pay the same amount of yield-to-maturity – on top of the annual coupon – of roughly 5.5% as the existing bonds.

The existing CB was initially issued at a size of HK$2 billion ($256 million), but following an earlier buyback exercise, only HK$1.405 billion remains outstanding. In April this year, the company also made a first attempt at getting the existing bondholders to give up their put option in exchange for a consent fee, which was accepted by investors holding about 15% of the remaining amount of bonds. This reduced the principal amount of bonds that may be put back to approximately HK$1.19 billion and taking into account the put price of HK$117.68 per $100 of principal, China Nickel will have to come up with a total of HK$1.4 billion ($181 million) if the CB is put back in full.

While not a huge amount, it is significantly more than the company’s cash on hand and cash equivalents of Rmb374.9 million ($56 million) at the end of June.

Given the cash constraints, China Nickel had the right idea when it tried to get rid of the pending put option through an offer to its CB holders in April. While the company offered the same consent solicitation fee of HK$20 for each HK$100 of principal, that deal was clearly not deemed attractive enough as holders of just 15% of the outstanding bonds chose to accept. Having gone it alone back in April (although Deutsche Bank was appointed as the agent to deal with the practicalities of the offer), the company has now mandated J.P. Morgan as the consent solicitation agent in the hope that its experience from other similar liability management exercises and restructurings will make a difference.

The exchange offer will remain open until November 8, and the existing bondholders will vote on whether to accept the removal of the put option on the outstanding CBs on November 10.

When the existing CB was issued in October 2007 with the help of Credit Suisse and Deutsche Bank, the sentiment surrounding the company was extremely positive. The share price had rallied about 245% that year and the company posted a five-fold increase in its first-half net profit. The five-year CB attracted more than $1 billion of demand, allowing the deal to be upsized to HK$2 billion from HK$1.5 billion initially.

The optimism stemmed from China Nickel’s transformation from a special steel manufacturer into an integrated stainless steel company, both through an expansion upstream, via a 14-year off-take agreement from an iron-nickel mine in Indonesia, and in the downstream segment of the market partly through the construction of a refinery nickel processing facility in China.

However, the global financial crisis that took hold in the first half of 2008 led to a significant drop in global nickel prices and left the company with sizeable losses both in 2008 and 2009. It also faced a delay of some of its planned expansion projects, including a steel mill project adjacent to the Indonesian mine where it has its off-take agreement, which saw the start of construction pushed back to this year.

Things have started to look up again, though. According to the company’s first-half earnings report, the recovery in the global economy this year has resulted in increased nickel consumption and it is estimated that the annual global nickel consumption will increased by approximately 10% in 2010. The demand for stainless steel will increased by 18% to approximately 30 million tonnes, and to 32 million tonnes in 2011. China Nickel also made a net profit of Rmb15.3 million in the first half this year, compared with a loss of Rmb79.9 million in the first half of 2009.