China's Hengan issues convertible with record conversion premium

An increase in capacity is expected to lead to continued earnings growth for hygiene products provider whose share price is already up 49% this year.
Hengan International Group last night (April 20) raised HK$1.5 billion through the sale of five-year convertible bonds that will go partly towards an ongoing expansion of its production facilities.

The deal, which was jointly led by Deutsche Bank and UBS, was priced with a conversion premium of 50%, which was at the top end of the indicated range and the highest ever for a Hong Kong CB. The previous record was 40% on an HK$1 billion CB issued by paper board manufacturer Lee & Man Paper in December last year on which Deutsche Bank was sole books.

That Hengan was able to achieve this even though its Hong Kong-listed shares are up 49% year-to-date and hit a record high earlier in the day shows investors do believe the provider of personal hygiene products will be able to continue growing its earnings once the new capacity comes on board.

Demand û both from specialist CB funds and long-only accounts û and the momentum in the book was said to have been very solid, which allowed the bookrunners to exercise an option to increase the deal size 25% from an original HK$1.2 billion. One fund manager said the allocations confirmed the book was multiple times covered.

There was said to have been a slight bias towards Europe in terms of interest, although Asian demand was also strong. The bonds werenÆt offered to US investors.

The conversion premium was indicated in a range between 45% and 50% over yesterdayÆs volume-weighted average price of HK$12.75 and was fixed at the top end to give a conversion price of HK$19.13. If fully converted, the new shares will account for about 7% of the companyÆs existing issued share capital.

HenganÆs shares closed at HK$13.15 yesterday, which was only marginally below the record high of HK$13.40 hit earlier in the session.

The bonds, which were issued at par, will pay no coupon, but are redeemable at 126.15% of face value to give a yield to maturity of 4.7%. The yield was indicated between 4.5% and 4.95%.

Investors can put the bonds back to the issuer after three years at 114.15% to achieve the same yield, which offers investors some additional downside protection should the share price fail to perform from now on. There is also an issuer call after three years, subject to a 130% hurdle.

The bond floor was fairly high at 95.2%, as could be expected with such a high premium. The implied volatility was 33.8%, compared with an historic volatility of 36%.

The underwriters provided asset swaps for 50% of the deal at a credit spread of 150 basis points over Hibor, although it was unclear last night how much of that had been taken up by investors. The underlying assumptions also included a divided yield of 3% and a stock borrow cost of 4%.

One observer noted that the companyÆs expansion plan and its strong 2005 earnings, which beat consensus EPS forecasts by about 3.5%, had provided a good backdrop for the bond sale.

ôHengan is essentially ChinaÆs version of Procter & Gamble with a very strong equity story. On top of that, the pricing seems to have been right and the timing was right in the sense that the market is very favourable towards Chinese stocks right now,ö he said.

According to the term sheet, the proceeds will be used partly to finance the companyÆs capital expenditure plan, partly to repay debt and for working capital purposes.

At the time of HenganÆs earnings release in mid-March, Deputy Chairman and Chief Executive Hui Lin-chit said the company would spend HK$650 million this year mainly to buy two new tissue paper production machines and eight new disposable diaper machines.

The company is aiming to double its production capacity of tissue paper to 240,000 tonnes and its diaper production capacity by 60% through the addition of new production facilities. This will help reduce costs by eliminating the need to outsource part of its production.

A new plant in Fujian province is scheduled to start operations in July and in the same month the company will also start construction on the second phase of its production base in the Shandong Province, which should be ready to go on stream in the second half of 2007.

The company reported a 51% rise in net profit to HK$450.3 million ($58 million) last year on a 32% increase in revenue to HK$1.26 billion ($162 million). The numbers helped to further underpin the share price, which has risen 184% through a steady climb over the past 12 months.

Despite the strong run, most analysts are still positive about the companyÆs future growth prospects, which are supported by a rise in disposable incomes in China. According to Hengan Chairman Sze Man-bok, the demand is partly fueled by new markets in third- and fourth-tier cities, towns and villages.

Of the 12 analysts following the company, six have a buy on the stock, four have a hold and two analysts recommend their clients to sell, Bllomberg Data show.

Aside from tissue paper and disposable diapers, the company also produces sanitary napkins and cleansing and skincare products.


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