China Overseas prices $500 million exchangeable

The issue sees strong demand despite a 50% exchange premium and a flood of new equity-linked paper over the past week.
China Overseas Holdings yesterday raised $500 million from the sale of bonds that are exchangeable into its listed property subsidiary China Overseas Land & Investment (COLI). Aside from the large size, the deal also stands out because of the 50% premium, which is the highest ever for a real estate developer in the Asia-Pacific.

It also matches the highest conversion premium recorded for an equity-linked deal into a Hong Kong-listed company.

The transaction comes only three days after KoreaÆs LG Philips LCD sold $500 million of convertible bonds and on the same day that Singapore-listed casino operator Genting International completed a S$450 million CB. China Infrastructure Machinery has also sold $287 million worth of convertibles in recent days. Despite this sudden burst of new paper, the market has seemingly no problems absorbing it. In fact, investors donÆt even seem to mind if the terms are on the aggressive side û as indicated by both deals yesterday.

True, the LG Philips bond initially traded down amid concerns that the deal was too pricey, but after the share price edged higher on the following day, the price came back up. The bonds are now trading around par, according to market participants.

ôIÆm surprised they are going for a 50% premium, but itÆs a clear sign of the strength in the market at the moment,ö one CB banker not involved in the deal says, with regard to the China Overseas bonds.

The issue attracted very strong demand from investors who were keen to participate in the developerÆs rapid expansion in China, and the deal was in fact priced at the most aggressive end û both with regard to the exchange premium and the yield. The latter was fixed at 3.8%, which marked the bottom of a 3.8% to 4.3% offering range and the premium could have been as low as 45% if set at the narrow end of the range.

According to sources, the bond issue was multiple times covered, even though individual orders were capped at 10% of the deal, or at $50 million. About 150 investors came into the deal, which was launched in the Hong Kong morning yesterday after the stock was suspended and completed in the early evening once London investors had had a chance to look at it.

The offer was arranged by Deutsche Bank, JPMorgan, Citi and China International Capital Corp. Deutsche and JPMorgan each underwrote 40% of the transaction, while Citi covered 14% and CICC, which given its lack of a CB franchise was likely included for relationship reasons, was responsible for 6%.

At the final premium of 50% over FridayÆs closing price of HK$10.62, the premium was the same as that used on Hengan International Group's HK$1.5 billion CB issued in April last year, which had a five-year maturity and a three-year put. HenganÆs premium was, however, fixed over the volume-weighted average price on launch day, which came at a 3% discount to the close and thus reduced the effective premium slightly. Countering that, the COLI bonds have a longer maturity at seven years with a five-year put, which would make it easier for investors to digest a higher premium.

Unusually though, the COLI bonds cannot be converted in the first three years, which suggests the parent company wants to hang on to the equity for another few years. Part of the reason for that may be to keep the voting rights, which will pass to the new owner once the bonds are exchange to equity. The high premium is also said to be a result of the company wanting to avoid too much dilution.

China Overseas Holdings currently owns 51.9% of the listco and if the bonds are fully exchanged the company will have to part with shares equal to about 3.5% of the company. Once the first three years are up, however, the issuer has the right to demand a mandatory exchange into equity, subject to a 130% hurdle.

According to one source close to the deal, investors were not too worried about the long non-conversion period since COLI is a stock that is easy to borrow (as indicated by the 1% stock borrow cost used for the pricing).

ôAs long as you can hedge the stock it is no problem as you can capture the equity value at any time by selling short,ö says one observer, adding that many investors did see this as a volatility play. That is a rare thing in Asia where a lot of CBs are based on stocks that arenÆt hedgeable and would have added to the attraction of the offering.

The bonds have a zero coupon and were issued at par. The underlying assumptions include a credit spread of 150 basis points, which was based on the fact that COLIÆs outstanding bonds, which have an investment grade rating, trade at a spread of 70-80 basis points. Investor will be protected against dividends if the payout ratio goes above 40% or 2.5% of the market cap.

This gave a bond floor just below 87% and an implied volatility between 40% and 40.5%. The 100-day historic vol is about 53% although for pricing purposes it was capped at 35%.

Despite the high volatility, COLIÆs share price has gained 97% over the past 12 months and is currently trading just off a record high close of HK$10.92 from last week. In March the company posted strong earnings for 2006 and said it added 6.5 million square metres of gross floor area to its land bank in China last year, spread on 19 plots of land in 11 cities.

On April 11 Credit Suisse said upgraded its recommendation of the stock to ôoutperform,ö noting that the developer has been able to keep a low net gearing of only 34% despite this aggressive accumulation of land, which means it still has a lot of room to grow its business. The company has also been able to achieve higher-than-expected selling prices for some of its recent and ongoing projects, it said in a report.

Credit Suisse raised its target price to HK$13.56 from HK$8.10, which is on par with its 24-month forward estimate of net asset value.

China Overseas, which issued the bonds through special purpose vehicle China Overseas Finance Investment (Cayman), said it will use the proceeds from the issue for debt repayments and general corporate purposes.
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