Cho Hung and Woori exchangeable mandated

There should be a full box at the Korean opera after the government appears to elicit a performance of musical chairs.

Three banks have been chosen to lead manage a $500 million exchangeable into Cho Hung Bank and Woori Financial Holdings after a second week of intense politicking. Goldman Sachs, JPMorgan and UBS Warburg will merge their respective propositions into one credible structure, which the government hopes to sell by the end of November. 

The three emerged victorious from a shortlist that also comprised Deutsche Bank and ING Barings. But the selection process has been fraught with controversy from the very beginning.

Bankers were initially incensed that they were only given two days notice to devise a complicated pitch, which JPMorgan already seemed to have made its own after six months pre-marketing its Opera structure (outperformance equity redeemables in any asset) to the government. Most annoyed is likely to have been UBS Warburg, which has long been considered the house bank of KDIC, in whose name the exchangeable is to be issued.

A panel of academics and officials from KDIC and the Ministry of Finance & Economy (MoFE) then heard all the proposals, in a move market participants deemed little more than window dressing, since JPMorgan was already thought to have secured the mandate. Although the government was to be congratulated for trying to make the selection process seem transparent, most bankers argued that it was a pointless exercise unless it operated a level playing field.

What then happened next is open to interpretation. One school of thought has it that all three banks were mandated at once. A second school believes that in a genuine effort to promote transparency, the government decided it couldn't appoint JPMorgan because it would look like a fix.

Consequently, UBS Warburg was accorded the most votes, with Goldman coming in second and JPMorgan third. After a day of intense discussions, however, JPMorgan was said to be back in the frame and may yet be joined by a domestic house, bringing the total number of bookrunners up to four.

Supporters of the government's attempts to sell down stakes in the two banks argue that the structure should not be viewed as an exchangeable but a going public bond. This is based on the fact that no investor would currently want to take the risk of exchanging into either Cho Hung, as it is currently capitalized, or Woori, which is not yet listed.

Since 1993 when Henderson China launched a going-public bond, there have been a number of issues from Asia, none of which have been very successful. After Henderson China, came Hutchison Delta Ports, which never listed, Lai Sun Development spin-off Asia Television which also never listed and in November 1996 New World China. However, bankers say that their performance has to be judged in the wider context of the Asian convertible market, which collapsed at the onset of the Asian crisis.

"In the early days, investors were so desperate to get into the Asian equity game that they'd buy just about anything," says one convertibles specialist. "They were even prepared to pay for downside protection that didn't even exist."

"A successful going public bond," he adds, "is one which behaves like straight debt until a trigger event such as an IPO, at which point the structure mutates into something else or is redeemed. With a normal convertible, an investor gives up yield for the value of the equity option. But if there"s no guarantee an IPO will take place, then clearly an investor is not going to want to pay up for the option. With a going public bond, there is no equity like performance until the IPO. These issues trade like fixed income instruments and tend to stay close to par."

Sometimes, this means that exchangeable investors are entitled to purchase the IPO at a discount to the offer price. Sometimes it means that the exchangeable becomes a convertible in return for investors giving up the premium redemption. Sometimes it means that the coupon drops at IPO.

Bankers cite two examples of deals this year, which the Korean government is basing its structures around. The first is a Eu2.5 billion Opera deal for Telecom Italia led by JPMorgan, which can be exchanged into either Telecom Italia Mobile or Seat Pagine Gialle.

In this instance, one of the chief attractions for the issuer is that it can choose which delivery option it gives investors. If an investor wanted to convert into stock A, for example, the issuer could choose to deliver stock A, the cash value of stock A, or stock B plus a penalty charge to compensate for the fact that investors would have to sell the unwanted stock B down into the market.

The second example is a Eu490 million going public bond for Germany's third largest utility, Energie Baden-Wurttemberg, launched in April via Deutsche Bank and UBS Warburg. Due August 2002, this has a coupon of 3% payable on maturity or at IPO and a redemption price of 102.9071%. At IPO, the structure becomes a convertible, with a conversion price of 19% to the stock's IPO price. The deal was also puttable at par on the IPO date.

A number of bankers believe that if nothing else, the government is at least signaling its determination to offload its huge holdings in the Korean banking sector and meet the IMF halfway. "These are not structures which will work for every issuer," one banker concludes. "If equity markets are shut or there are technical difficulties, they suit borrowers which want to send a message to the market. They say, 'we are not doing this deal because we need the debt but because we want to float this company and we cannot do so right at the moment'."

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