Country Garden opts for convertible

The $500 million CB is paired with a share buy-back to address a desire among investors to be able to hedge the equity option.
Chinese property developer Country Garden Holdings has raised Rmb3.6 billion ($500 million) from the sale of convertible bonds three months after it called off a $1.5 billion high-yield bond offering in response to difficult market conditions.

The financial markets havenÆt really improved since then and Country GardenÆs share price has also fallen another 46%, which makes a CB a good funding choice for the company (since it allows it to raise equity funds at a future share price). Investors who believe the developerÆs share price will return to its earlier highs or at least recover a good part of the recent losses once the equity markets stabilise again, would be natural buyers û at the right price û while CB specialists like the high volatility of the stock.

To add to the attraction, the company combined the CB with a share buy-back which was carried out through a cash-settled equity swap of approximately $250 million. The counterpart on the swap was Merrill Lynch, which also arranged the convertible. By passing on the resulting short position to the market, Merrill effectively provided investors with the ability to hedge the equity element of the CB, something which investors have made pretty much a requirement for buying equity-linked deals recently.

The use of a cash-settled equity-swap structure appears to have been a way of avoiding reducing the free-float, which is already very low. Thanks to its large market capitalisation, Country Garden obtained a waiver from the usual 25% free-float requirement at the time of its initial public offering in April, enabling it to sell only 16.9% of its share capital (including the greenshoe) to the market.

The share buy-back itself would also have sent a signal to investors that the Country Garden management feels its share price is cheap û after all it was willing to spend half the proceeds from the CB to buy its own shares at this price. This was only the second time that an Asian company had issued a CB that was linked to a share buy-back, the first one being a $200 million exchangeable into casino operator Melco PBL Entertainment in August last year, which was also arranged on a sole basis by Merrill Lynch. According to the Country Garden term sheet, the US investment bank is referring to the structure as a convertible equity appreciation security (CLEARS).

This deal too went well, with more than 30 investors said to have participated. Based on their allocations a couple of investors estimated that the deal had been close to two times covered. According to one source, the bonds traded up to 100.5-100.75 after the deal was completed on Friday evening. There is a $100 million greenshoe, which may be exercised within 30 days if the bonds continue to trade above par.

Several observers said they werenÆt impressed by the credit spread guidance of 725bp, however, arguing that a much wider spread of 900bp or even approaching 1,100bp would have been more appropriate. The 725bp spread was supposedly based on an outstanding bond for fellow Chinese developer Shimao Property Holdings, which trades at about 800bp and has a longer maturity. Shimao is also only about half the size of Country Garden, which has a current market cap of about $13.5 billion. The wider the spread investors used in their models, the less attractive the valuation became. Consequently, it was no real surprise that the conversion premium was fixed at the bottom of the 37.1% to 47.1% indicated range. The yield to put was fixed at 6.2% after being offered at 5.75% to 6.25%.

The high yield in combination with an annual 2.5% coupon means the financing terms arenÆt that great for the company, but at least it was able to distribute its CB in full and raise the money needed to repay a loan that is coming due over the next couple of months. Part of the credit for that must go to the share buy-back structure. Without that, it is unlikely that the company would have been able to get away with a conversion premium above 35%, observers say.

However, the current premium gives an initial conversion price of only HK$9.05 (it was set over the volume-weighted average pricing in the morning session on Friday) which is well below the closing high of HK$13.76 that was reached in mid-September this year. And given that the stock has a 100-day historic volatility of more than 50%, it certainly looks within reach. The stock has fallen 51% from its highs to the morning session close of HK$6.71 on Friday (it was suspended in the afternoon when the CB was being marketed), but is still trading above its IPO price of HK$5.38. The recent trading pattern suggests there is support at around HK$6.

The bonds have a five-year maturity, but can be put back to the issuer after three years. There is also an issuer call after three years, subject to a 130% trigger. The bonds are denominated in renminbi to prevent the company from having to mark-to-market the equity option, as it would have to do if it chose to issue in a currency other than its functional currency such as US dollars. Like the other renminbi-denominated CBs that have been sold in the international investors over the past year, the Country Garden CB will be settled in US dollars, however.

While this type of bonds were well-received by the market in the first half of last year as they allow investors to capture the expected appreciation in the renminbi during the life of the bond, sources say they are a harder sell in the current market environment as investors are concerned about being able to hedge the credit portion of the bonds. The issue here is that there are no asset swaps or credit default swaps available that take account of the renminbi structure, making the hedge less than perfect.

ôInvestors are very worried about credit protection at the moment and the issuers that have addressed that have been well received by the market,ö one observer says.

Depending on which credit spread one uses, one investor says the implied volatility would come out at about 25% to 26%, while the bond floor will range from approximately 93% to 96%. The underlying assumptions include a conversion price adjustment if the company makes a dividend payout that exceeds 40% of its net profit.

Like other Chinese property companies, Country Garden will have to raise more money over the next few years to fund its ongoing developments and the company is expected to attempt a return to the international bond market when the sentiment becomes a bit more favourable towards high-yield issuers. This CB is the first fund raising by a Hong Kong-listed Chinese property developer in the capital markets since Coastal Greenland completed a $100 million high-yield bond with warrants on October 31, and may improve the confidence among issuers that deals can get done with the right price and the right structure. The latest equity placement was as far back as September 20 when Kerry Properties raised $533 million and Beijing Enterprises pocketed $476 million in two separate transactions.

The Country Garden CB is also a bit of a coup for Merrill Lynch, which was neither part of the companyÆs IPO nor of the postponed high-yield bond. The latter included no fewer than seven bookrunners - Bank of China, Citi, Deutsche Bank, JPMorgan, HSBC, Morgan Stanley and UBS û while the IPO was arranged by Morgan Stanley and UBS. According to sources, Morgan Stanley and Goldman Sachs have both been sounding out the market for a CB in recent weeks, indicating that there was some competition to do a deal. The same sources say that the CB was fully underwritten by Merrill.
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