After more than 30 hours of trying to patch together a deal and a two-day suspension of the stock, Dongyue Group early Friday evening called off its renminbi-denominated convertible bond offering and the concurrent placement of secondary shares to be sold mainly by its largest shareholder.
The company, which is the leading producer of refrigerants and polymers in China and also makes organic silicon, was looking to raise at least Rmb632 million ($100 million) from the CB, while the placement was targeting between $115 million and $122 million.
The cancellation of the deal came after several other companies have seen their share prices underperform following recent placements and after a disappointing performance of most of the CBs that have come to market since the beginning of March. A scrapped deal is clearly not a good signal, whatever the reason.
The CB was supposedly no issue. It was covered at the investor-friendly end of terms by lunchtime on Thursday (the CB and the placement were both launched Thursday morning Hong Kong time after the stock was suspended from trading) and in the late afternoon the bonds were quoted at about 101 in the grey market. But because the CB was to be priced off the placement price, it couldn’t be wrapped up until the placement was also a done deal. And that proved a challenge.
Aside from the 131 million shares that sole bookrunner UBS was trying to sell on behalf of Dongyue’s controlling shareholder, Macro-Link International (111 million shares), and Dongyue Initiator (20 million shares), which is owned by the company’s CFO, it was also trying to sell enough shares to cover the delta on the CB. In other words, it was helping the CB buyers to offload enough shares to hedge the equity option — a crucial element as most hedge funds will only participate in a CB transaction if they can do the delta hedging.
Observers estimated that this would add another $30 million to $40 million worth of shares to the placement and feared that there wasn’t enough demand to absorb the entire transaction. Speculation that this was the case persisted even though UBS told investors by about 6pm on Thursday that the placement was fully covered. A source also noted that the fact that there was a fair bit of demand from European outright investors and high-net-worth accounts for the CB meant that there was a need to sell fewer shares to cover the delta than expected by the market, probably only $20 million to $25 million worth.
But the deal wasn’t completed on Thursday night — even though the order books closed about 10pm — and the stock remained suspended on Friday, leaving market participants in the dark about what was going on and whether there would be a deal at all.
The failure to produce a deal led some people to question whether the combination of a CB, where the company is selling shares at a premium, and a placement by the controlling shareholder at a discount, was the right thing to do. And there was of course also speculation that the price range was too aggressive for the deal when including the delta placement as well.
However, the source said UBS did have a deal at the bottom of the price range when the books closed, but Macro-Link didn’t accept it — even though it had supposedly agreed to the price range before launch. According to the source, the demand was very price sensitive and it wasn’t really possible to raise the price even for a smaller deal size. Also, UBS was doing the deal on a best-efforts basis so there was no reason for it to push investors for a price that there clearly wasn’t any support for.
However, the bank did suggest that Macro-Link sell fewer shares at the same price, which would allow it to raise some money now and sell the rest of the shares at a potentially higher price in future. More importantly, it would also allow Dongyue to go ahead with the CB, which was meant to help fund its continuing capacity expansion.
Another option would have been to cancel the placement and go ahead with just the CB, which many observers argued would be the best option for the company. Although that would have required a renegotiation with investors about the terms, as the conversion premium could no longer have been set over the placement price.
The discussions with both the sellers and investors continued throughout the entire trading day on Friday, but Macro-Link, which owns about 33.5% of Dongyue, supposedly didn’t budge. Eventually, UBS decided that the deal couldn’t be salvaged and by about 6pm investors were told that neither the placement nor the CB would proceed.
The cancellation would have been a disappointment to Asian CB investors in particular, as many of them are sitting on a lot of cash and so far this year have had few opportunities to invest it. And, as mentioned, most of the recent deals have traded poorly.
But it would, of course, have been a disappointment to the company as well. According to the term sheet, the money raised from the CB was to be used to fund capacity expansion, research development and general working capital.
The source said Dongyue has a strong enough cashflow to fund its capacity expansion programme, and at the end of last year it had Rmb1.5 billion ($237 million) of cash and bank balances. But clearly the extra funds could have been put to good use. Among other things, the company is in the process of acquiring the exploration rights to a nickel mine and an iron and fluorspar mine in the Inner Mongolia region in China at a combined cost of Rmb80 million. The acquisition, which is expected to be completed this month, will strengthen Dongyue’s vertical integration across the entire fluorchemical value chain and will provide it with an opportunity to ensure a reliable supply of high-quality fluorspar and other relevant mineral resources that account for the majority of its raw materials supply, according to earlier stock exchange filings.
The fluorspar is used in the production of refrigerants, which are used in air conditioners and refrigerators, and as a feedstock for fluoropolymers, which are widely used in the construction, electronics, automobile and aerospace industries.
It is unclear why Macro-Link would put its own interests ahead of those of the company, except that it seems focused on raising a particular amount of money. Market participants noted that Macro-Link recently tried to do a placement through a different bookrunner, but backed out before launch as it supposedly didn’t like the price then also. And the confusion about what was happening on Friday seems to have been made worse by the fact that Macro-Link was approaching other banks to help it put together a deal while the stock was suspended.
As of 11pm last night Dongyue had still not issued a statement that might explain the decisions leading up to the cancellation of the deal. The company will need to issue some form of statement before the stock can resume trading again.
The CB had a base size of Rmb632 million plus an upsize option of Rmb189 million, that could have allowed the company to raise up to $130 million. It had a five-year maturity and a three-year put and was offered with a coupon and yield ranging from 3.75% to 4.75% and a conversion premium of 20% to 27.5% over the reference price, i.e. the placement price.
As noted, the coupon and premium were both set to be fixed at the investor-friendly end, resulting in a 4.75% coupon and 20% premium.
Meanwhile, the placement accounted for 131 million shares, or 6.2% of the company. The shares were offered in a range between HK$6.80 and HK$7.20, which translated into a discount of 3.5% to 8.8% versus Wednesday’s closing price of HK$7.46.
Dongyue’s share price took a big hit when global stock markets fell last autumn, tumbling from just over HK$9 to a low of HK$3.14 in early October — less than HK$1 above its IPO price of HK$2.16 in 2007. However, it has recovered the bulk of those losses since then and last month reported very strong earnings for 2011.
The company said its total production exceeded 2 million tonnes, which was up 28.5% from the previous year. Revenues gained 70% year-on-year to Rmb10.2 billion, while net profit jumped 198% to Rmb2.2 billion.