CB offering

Chinese developer upsizes CB to $284 million

Generous pricing and support from DBS boosts demand for China Overseas Grand Oceans Group's Hong Kong dollar-denominated CB.
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Potential buyers check out a property fair in the Chinese city of Hangzhou (AFP)</div>
<div style="text-align: left;"> Potential buyers check out a property fair in the Chinese city of Hangzhou (AFP)</div>

China Overseas Grand Oceans Group, a state-backed Chinese property developer, early yesterday morning priced its Hong Kong dollar-denominated convertible bond issue at the issuer friendly end and exercised part of the upsize option for a total deal size of HK$2.2 billion ($284 million).

The deal launched at about 7.30pm Hong Kong time on Tuesday, hot on the heels of a slightly smaller CB that was being offered by sportswear manufacturer and retailer 361 Degrees (see story on our website yesterday), and closed a couple of hours later. Despite the competition and the later start, the China Overseas transaction was quickly covered, which sources said was partly due to the momentum created by a pre-launch wall-crossing exercise that brought in a number of convertible bond investors to anchor the deal. According to one source, about 60% of the base deal was already covered at launch.

However, the deal was also viewed as being very cheap. Crucially, it came with a standby letter of credit from DBS, which essentially means that the issuer is borrowing DBS’s investment grade rating to get a better pricing on the deal. Even so, the CB was offered with a coupon and yield between 2% and 3%, which observers said was highly excessive for one of Singapore’s top credits. The coupon was eventually fixed at 2%, but together with a credit spread of 150bp, this still resulted in a bond floor of 99% -- in other words, investors are basically getting the equity option for free.

As a further indication of the generous pricing, the CB traded up to about 103 to 103.25 yesterday afternoon as investors who were scaled back on the night were trying to pick up bonds in the secondary market. The share price fell 1.5%.

However, people close to the deal argued that investors had to be compensated for the fact that the CB came with a number of unusual features, including a two-year non-conversion period. It was also structured to give the appearance of being a three-year deal, even though it did actually have a five-year maturity with a three-year put. For example, there are no coupon payments after the first three years, and the letter of credit from DBS is also only valid for three years. While it would seem easier, and significantly less confusing, to just issue a straight three-year deal, the company had shareholders’ approval for a five-year transaction and, according to a source, it would have been very time consuming to go back and change that.

The long non-conversion period was said to have been prompted by the fact that the company, and its controlling shareholders, were very keen that there shouldn’t be any dilution in the first two years.  

Deeming from the level of demand, investors didn’t really see these as significant hurdles, however. One source noted that the total amount of orders was close to HK$10 billion, or five times the size of the base deal, and 114 investors participated in the transaction. The mix of investors was also pretty good with 66% of the deal said to be allocated to asset managers, while 22% went to hedge funds. The rest was mainly bought by banks, except for about 1% that went to private banking clients.

The stock isn’t hedgeable, but the hedge funds were supposedly attracted by the high bond floor. China Overseas Grand Oceans is a high-growth property developer that is majority-owned by China Overseas Land and Investment (COLI), which is one of the largest property developers in China. While COLI is active primarily in tier-1 and tier-2 cities in mainland China, China Overseas Grand Oceans is focusing on third- and fourth-tier cities, which are less affected by the government’s attempts to reign in prices and speculative buying. Indeed, in this part of the market gross selling prices are still rising strongly.

The CB was launched at a base deal size of HK$2 billion with an upsize option of HK$300 million. It also came with a 2% to 3% coupon and yield and a conversion premium of between 20% and 30% over Tuesday’s close of HK$9.64.

Given the size of the demand, the company could easily have exercised the entire option to raise the maximum – especially since most of the demand was described as being price insensitive. However, taking into account the amount of funds it needs and the potential dilution, China Overseas decided to use only two-thirds of the upsize option and increase the total deal size to HK$2.2 billion.

However, the coupon (and yield-to-put) was fixed at 2% and the conversion premium at 30%, for a total conversion price of HK$12.532. Instead of an issuer call, the deal comes with a mandatory conversion feature after three years, subject to a 130% hurdle.

Based on a 150bp credit spread, the implied volatility was in the low teens. However, this was somewhat academic since the stock isn’t eligible for short-selling, and hence the equity option cannot be hedged. Consequently, the stock borrow cost was assumed at 5% and according to the term sheet, investors will be compensated for dividend yields above 2.5% of an annual payout ratio of 30%, whichever is lower.

BOC International and DBS were joint bookrunners.

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