China National Offshore Oil Corporation (CNOOC) raised $850 million last night (Thursday) from a debut convertible deal. Timing of the transaction caught the market slightly off guard given the US was shut for Thanksgiving, but it was not altogether surprising given that CNOOC is strongly rumoured to be in negotiations with Shell to purchase its 34% stake in Australia's Woodside Petroleum, currently valued at $2.47 billion.
The $750 million deal, upsized to $850 million, represents the largest and arguably most aggressively priced CB to ever come out of China. The leads also have an option to upsize the deal to $1 billion and if this is exercised, it will place it equal first with a $1 billion four tranche deal from Taiwan's Formosa group as the largest equity-linked deal from Asia this year.
Lead managers were JPMorgan, Merrill Lynch and UBS. Merrill's has long been a house bank of CNOOC, while JPMorgan has been the most aggressive CB house in Asia this year and UBS has rare experience of the China market, having recently done a CB for Beijing Datang Power. The most notable omission was CNOOC's other traditional house bank, Credit Suisse First Boston, which was credited as a joint-lead alongside Goldman Sachs.
Pricing a deal for CNOOC was said to have been relatively straightforward given there is a very liquid CDS market to price the BBB+ rated credit off and a lot of stock borrow to hedge the equity option. The main problem was the sheer aggression of banks pitching for the deal, which pushed indicative pricing to unsustainable levels.
This soon became abundantly clear within an hour of launching the deal and the three leads decided to eat some of their 1.75% fees and re-price it one point below par at 99%. The five-year deal has a zero coupon and redemption price of 105.114% to yield 1%. There is also a put option after three years with a price of 103.038% and a call option after three years with a 130% hurdle.
The conversion premium was marketed on a 35% to 45% range and priced at 35% to the stock's spot close of HK$4.475.
Underlying assumptions based on an offer price of 99% comprise a bond floor of 92.6%, implied volatility of 27.5% and fair value of par. This is based on a credit spread of 30bp over Libor, stock borrow cost of 50bp, dividend yield of 2% (investors are protected above this level) and historical 100-day volatility of 32%.
Based on an issue price of par, the bond floor comes out at 91.74% and implied volatility at 29.7%. For investors, the key sensitivity was said to have been the volatility.
Unlike most Asian CB's CNOOC has a lot of stock borrow - bankers calculate there was about $300 million available. This means the stock is likely to come under some pressure when the deal re-opens for trading today (Friday), as funds hedge the equity option. Bankers estimate that delta hedging could amount to up to $200 million to $250 million, representing about 10 days trading volume.
Once the deal had been re-priced, books went on to close just over two times covered, with participation by roughly 93 accounts.
"Volatility was the key determinant of this transaction," says one specialist. "Investors are very sensitive about the likelihood of volatility levels dropping. In Europe, many accounts have been crushed by a drop in secondary market volatility levels from the 27% - 28% area to 22% - 23%. This deal has come at a premium to that."
CNOOC's slightly out-of-the money short-dated traded call options are currently said to be trading in the high 20's.
The other sensitivity was the conversion premium, given how much CNOOC has run up this year on the back of record high oil prices. The stock is currently up 47.2% year-to-date and is hovering around its 52 week high of HK$4.575.
At this level it is trading on a 2005 P/E multiple of about 10.5 to 12 times and an EV/EBITDA level of 6.5 times. Woodside Petroleum is trading at a 35% premium in EV/EBITDA terms. A near-term catalyst for the stock will be its intention towards Woodside.
Analysts see a number of synergies between the two, though the Australian government's attitude is likely to be a swing factor since it previously blocked attempts by Shell to use its 34% stake to take over the whole company. This was done because Woodside owns a portion of the country's North West Shelf project, which has been deemed a strategic national asset. CNOOC currently owns 5% of the project and has signed a $14 billion contract with the consortium of owners to pump LNG to China.
During the first half of the year, CNOOC reported earnings of Rmb7.042 billion ($858 million), up 11.2% from the same period the previous year. Total oil and gas production from both its onshore and offshore fields was up 4.3% to 66.6mmboe. However, while gas volume was up 9%, oil volume was flat.
The company also said that its lifting cost (a key efficiency measure) rose from $2.82 to $3. However, it said it took advantage of high oil prices to pump oil out of fields, which it would not be able to do so easily when oil prices are low.