Guangdong Investment CB

Exchangeable into Guangdong Investment defies tough market

Issued by an investment company owned by the Guangdong provincial government, the deal attracts good demand from investors despite the fact that the bonds cannot be exchanged for the first two years.

Ignoring the challenging market environment, investment holding company GDH Limited last night raised $250 million from the sale of bonds that are exchangeable into its Hong Kong-listed subsidiary, Guangdong Investment.

The deal came as Guangdong Investment’s share price has risen 8.9% during the past couple of weeks, bringing it close the 2011 high of HK$4.31 that it reached in January. The company clearly saw this as an opportunity to raise some cash, but the fact that it chose to do a deal at a time when widespread concerns about growth is putting pressure on equity markets around the world — European markets were down a couple of points during the bookbuilding — also suggests that it may not expect markets to improve any time soon.

Even so, the exchangeable bond (EB) received pretty good demand from investors, who liked the fact that GDH is wholly-owned by the Guangdong provincial government. This gave them a lot of comfort in the credit and helped them overcome some less appealing features of the EB, including a high exchange premium, a high dividend protection threshold and the fact that the bonds cannot be exchanged into equity for the first couple of years.

Interestingly, this is the second exchangeable bond by a Chinese government entity in just a few months, after an investment company owned by the Tianjin municipal government sold Rmb1.311 billion ($200 million) worth of bonds exchangeable into its Hong Kong-listed infrastructure and utility unit, Tianjin Development Holdings at the end of March. Whether this is a new trend remains to be seen, but it is possible that these entities want to diversify their funding sources as credit in the domestic bank and bond markets is getting tighter. The last time Chinese government entities made use of the overseas equity-linked market to raise capital was in 2006 and 2007 when share prices were rallying.

If fully converted, GDH’s stake in Guangdong Investment will fall to about 53% to 54% from 60.4% at present, meaning it won’t lose any of its control as a result of the sale. Guangdong Investment is active in a variety of businesses including electricity generation, infrastructure, real estate and department stores. However, its key business is the supply of water to Hong Kong, Shenzhen and Dongguan. It owns one of the largest water transmission systems in China and is one of the largest listed water supply operators in Asia.

The EB has a five-year maturity, but can be put back to the issuer after three years. It was offered with a coupon and yield ranging from 2.5% to 3% and an exchange premium of 30% to 40%. Both were fixed at the investor-friendly end, which was no surprise in light of the market environment. Investors may still be willing to participate in deals they like, but they are not keen to give on pricing. The $50 million upsize option was also not exercised, although GDH still has the ability to do so within the first 30 trading days.

This resulted in a 3% coupon and a 30% premium over yesterday’s close of HK$4.27. The latter in particular is still a good deal for the issuer though, as it resulted in an initial exchange price of HK$5.551. This is 20% above the HK$4.62, which marks the peak for Guangdong Investment’s share price since the global financial crisis. And it is only 1.4% below the company’s all-time high from July 2007.

According to a source, about 70 investors participated in the trade, with the demand split fairly equally between outright investors, who were attracted by the coupon, and hedge funds, which liked the fact that there is plenty of stock borrow available in the market. Somewhat surprisingly, slightly more than half of the demand — one source estimated about 60% — came from Europe, while the rest was sourced out of Asia.

Late yesterday evening (Hong Kong time), the EB was quoted slightly above par at 100.25 in the grey market, although sources said there wasn’t much trading.

The bonds were marketed at a credit spread of 300bp, which was the same as on the EB into Tianjin Development. GDH is slightly larger than its counterpart in Tianjin, but given that the market environment has deteriorated since March, that was still considered fair. The stock borrow cost was assumed at 1.5% and bond holders will get compensated for dividend payout exceeding a yield of 3.51%. The latter is equal to the historical dividend yield indicated by yesterday’s closing price.

This gave a bond floor of 97% and an implied volatility of 18.5%, which compares with an historic volatility of about 23%.

The deferred conversion is not a feature that is particularly popular by investors, but it is something they may have to get used to if more government-owned entities are to start issuing exchangeable bonds as a means to raise capital. The reason to use it would be to prevent diluting their holdings in the underlying stock in the near-term. The Tianjin Development EB also had a deferred conversion, although only for one year. The two-year delay on the Guangdong Investment EB is the longest since Tata Motor’s $450 million issue of five-year convertible alternative reference securities, or “cars”, in June 2007, which weren’t convertible for the first 4.25 years.

GDH didn’t specify how it plans to use the money, saying only that it will go towards general working capital and potential acquisitions.

The deal was arranged by J.P. Morgan, which was also the sole bookrunner on the EB into Tianjin Development earlier this year.

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