If something's worth doing, it's worth copying – and equity capital market deals are no exception.
China Shipbuilding Industry Corporation (CSIC) underscored that point on Wednesday, when it sold $1 billion of bonds exchangeable into shares of Hong Kong-listed Postal Savings Bank of China (PSBC). Rather than dreaming up something completely new, CSIC largely followed the model set just six months earlier by Shanghai International Port Group.
The earlier convertible was hailed by FinanceAsia's awards judge as 2017's Best Equity Deal for achieving a near-impossible mission – monetising PSBC's notoriously illiquid shares through the equity-linked route.
Likewise, it didn't take long for CSIC to recognise the deal’s success and launch its own bond sale in a similar format. As with Shanghai Port, the new exchangeable bond could see CSIC exit nearly half of the $2.2 billion investment it made in the lender through its initial public offering in October 2016.
Now, all eyes will turn to the other cornerstone investors who joined PSBC's jumbo IPO. It would be no surprise to see more cornerstones look to exchangeables as they seek to cash out.
CSIC and Shanghai Port were two of the six cornerstone investors in PSBC’s IPO. The other four were troubled conglomerate HNA Group ($1 billion), State Grid ($300 million), China Chengtong Holdings ($150 million) and China Great Wall Asset Management ($100 million).
Devil in the details
When the transaction launched late Wednesday afternoon, equity-linked investors naturally compared the terms with Shanghai Port’s note. Since the two deals were identical in size, it made the new deal potentially a good substitute for the existing one.
However, on closer inspection it proved there were some key differences in structure.The most obvious difference was that CSIC opted for a longer seven-year deal, while Shanghai Port issued its dual-tranche note with tenors of four and five years.
CSIC’s new deal offered less flexibility but it was clear it had studied Shanghai Port’s subscription results last year, which showed investors prefer longer tenors for PSBC-backed exchangeable notes because of the stock’s low volatility, making hedging activities less likely to succeed in the short term.
Still, the market appeared to have a hard time finding consensus on a credit assumption due to the deal’s complex structure.
Unlike Shanghai Port’s exchangeable bond, which was issued with full guarantee, CSIC picked a special purpose vehicle named Poseidon Finance 1 for the bond issue and provided credit support indirectly.
Through collateral and securities lending agreements, Poseidon Finance 1 was connected to CSIC Investment, which was supported by CSIC through a keepwell deed.
This two-layer structure implies Poseidon Finance 1 may not be guaranteed by CSIC in case of liquidation. In fact, one bond trader pointed out the trade was effectively a pledge of PSBC shares by CSIC, but structured in an exchangeable bond format.
This complexity comes on top of the fact CSIC itself in not internationally rated, making credit assumptions for the new deal even more difficult.
Given CSIC’s state-owned status and its majority stake in two Shanghai-listed companies, China Shipbuilding Industry and China Shipbuilding Industry Group Power, some market participants have assumed a credit spread of 85 basis points for the new deal – on par with A1/A+ rated Shanghai Port’s previous issue.
However, some market participants assumed a credit spread of as high as 150 basis points due to the complexity of the deal structure. The lead banks were said to guide investors around the 100bp mark.
CSIC’s zero-coupon seven-year deal – including a four-year put option – was pitched at a yield-to-maturity of 0.75% to 1.25%, puttable at 103.04% to 105.11% and redeemable at 105.38% to 109.11% At final pricing, the deal was fixed at 1% yield-to-maturity.
In terms of exchange premium, the new deal was marketed at 20% to 30% over PSBC’s HK$4.82 Wednesday close, before settling at the mid-point of 25% and a strike price at HK$6.025.
The final price was fairly in line with Shanghai Port’s existing deal yielding 0.75%, considering that the US has raised its benchmark rate by 25bp over the past six months.
For investors, the new deal’s richer exchange premium was offset by full dividend pass-through. Shanghai Port’s existing issue was sold at 20% premium and dividend protection above 15 Hong Kong cents.
It is worth noting that the deal was launched on the back of a strong rally in PSBC shares amid an overall rebound in the banking sector, making the new bond more attractive from a volatility perspective.
Based on the official credit assumption of 100bp, the new bond has a bond floor of around 91% and an implied volatility of around 21%.