CKI takes hybrid route to improve finances

Cheung Kong Infrastructure finds strong retail support for its $1 billion issue of perpetual securities.

Cheung Kong Infrastructure Holdings (CKI) made a successful move to reduce its gearing level earlier this week with the sale of $1 billion worth of perpetual hybrid securities. The capital-raising attracted strong demand from retail accounts, impressed by the familiarity of the name and by the unique nature of the securities.

CKI raised the cash through a special purpose vehicle (SPV) called PHBS Limited, which it fully guarantees. J.P. Morgan, which has a successful track record advising companies that issue hybrid securities, acted as sole bookrunner and lead manager for the deal. The US bank also provided a supportive bid from its private banking division.

The securities were re-offered at par and pay a semi-annual coupon of 6.625% -- with the first payment on March 29 and the next on September 29, 2011.

The deal was described by bankers as “issuer friendly”. There are no change of control clauses, and no coupon step-up if the bonds aren't called. The pricing also seemed skewed in favour of the borrower.

The securities were marketed on an absolute yield basis. During the company’s Hong Kong roadshow last week the target was for a 7% yield, but that was lowered at the beginning of this week when the travelling bankers and company representatives moved on to Singapore.

 At least one major bond trading house in Asia decided that the deal was too tightly priced, and argued that it should have been sold at a yield of 6.875% -- that is, cheaper than a proximate issue by Petroleos Mexicanos (Pemex), whose perpetual notes rank pari passu with the company’s senior unsecured debt. It also looked expensive compared to recent issues by European utilities such as Scottish Southern Energy and Suez Energy Resources.

Yet, the same house conceded that the issue should be well supported at current levels, given the strong interest from private banks and the fact that it is a unique issue in Asia and is issued by a well-known credit.

The total demand was $5.2 billion, split across 167 orders. The issue was sold under Regulation-S only, meaning onshore US investors couldn’t participate.

By far, the majority of the bonds (87%) were placed with Asian accounts, with the remaining 13% distributed in Europe. CKI and its ultimate controlling shareholder, Li Ka-shing, has a big fan base among Asian retail investors – especially in Hong Kong – and that was reflected in the type of accounts that were allocated bonds. Retail bought 55% of the issue, asset and fund managers took 36%, commercial banks 7% and the other 2% was placed primarily with pension funds and life insurance companies.

At the close of business on Wednesday the securities were trading at 100.40-100.50 in the secondary market.

The securities have been designated as hybrid equity by the major credit rating agencies. Standard & Poor's (S&P) said on Wednesday that it classifies the issue as "intermediate" equity credit for credit analysis purposes. This means that it will treat the securities as 50% equity and 50% debt in its ratio calculations. They are classified as subordinated securities of CKI.

While the securities have no final redemption date, they can be called by the issuer in year five, or on any coupon date after that. They can also be redeemed by the borrower at any time, if there is a detrimental tax, accounting or ratings event. In particular, this clause is designed to protect CKI from any change in rules regarding the treatment of hybrid securities as equity capital.

Unusually, there is no step-up coupon or additional yield related to any of these events. If the securities are redeemed, investors will simply be paid par plus any outstanding interest. The issuer is also allowed to defer coupon payments at its discretion, but unpaid interest will be accumulated, compounded and paid to investors at later coupon dates.

PHBS is also subject to mandatory interest deferrals; payments must be deferred if CKI breaches pre-set financial triggers, including a funds-from-operations-to-interest ratio of less than 1.5 times, and a total debt-to-total-capital ratio of more than 60%. Currently, CKI is operating well within those limits. Its cashflow coverage ratio is 7.5 times and its leverage is 15%, according to sources familiar with the deal.

But, there is also a so-called dividend stopper clause, whereby there can be no dividend payouts on common shares if the distribution of coupons on the hybrid issue – whether voluntary or forced -- is deferred. Conversely, if a dividend is declared within three months of the coupon date, then interest on the securities has to be paid.

Although S&P hasn’t rated the issue, it pointed out that "intermediate" equity instruments that are subordinated to senior obligations and include a mandatory payment deferral clause, are typically rated three notches below a company's issuer rating because of recovery considerations should company liquidation ever occur, and due to the greater risk of  payment deferral compared with senior debt. CKI is rated A- by S&P and its credit is currently on negative watch.  

CKI is 84.58% owned by Hutchison Whampoa, Hong Kong tycoon Li Ka-shing’s flagship holding company. Hutchison is approximately 49.97% owned by Cheung Kong (Holdings), which as of June 2010 was about 40% owned by the family trusts of Li. Hutchison is a Hong Kong-based conglomerate with a significant presence in Asia and Europe. Its core businesses span ports and related services, property and hotels, retail, telecommunications, energy, infrastructure, finance and investments.

Moody's Investors Service said on Wednesday that it continues to review Hutchison's A3 issuer and senior unsecured bond ratings for a possible downgrade. It put Hutchison on review for a possible downgrade in August, following CKI’s participation in a bid to buy a UK electricity distribution network from EDF Energy, as the deal raised concerns about the company’s gearing levels.

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