First CB by an Indian BPO firm

Firstsource raises $275 million to re-finance its recent MedAssist acquisition in the US.
Indian business process outsourcing firm Firstsource Solutions has raised $275 million from a convertible bond that will allow it to replace a bridge loan put in place over the past month to pay for a recent acquisition.

This was the first convertible bond issued by an Indian business process outsourcing (BPO) company, but given the increasing acquisition appetite within the sector, it is likely that more issuers will tap into this opportunity to achieve lower-cost funding. Investors have a strong appetite for Indian equity-linked paper because supply has been reduced since new regulations were brought in this August.

FirstsourceÆs bonds also traded well in the secondary market, with the bonds rising slightly to 100.25-100.5 post-pricing, suggesting there was some follow-through buying.

Because investors like the companyÆs equity story and its value-accretive acquisition of US-based MedAssist Holdings, a provider of revenue cycle management for the US healthcare industry, Firstsource was able to price the bonds tight. The issue was also well-timed to take advantage of a near two-year low in the five-year swap rate, one source says.

As a result, the company was able to replace an annual floating-rate interest cost of 250bp over Libor (at current rates about 7.2%) with a fixed 6.75% per annum yield. And if the companyÆs positive views on its share price play out, it wonÆt have to pay any of that as the yield will only be paid out in case the bonds are redeemed at the end of their five-year life û these bonds would be expected to convert into equity before then. There are also no annual interest payments to worry about as the bonds have a zero coupon.

Also contributing to the pricing was the fact that ICICI Bank stepped up and provided a credit bid in the form of $50 million worth of credit default swaps at 350bp over Libor which was said to have been taken up in full. ICICI was a joint bookrunner on the deal together with JPMorgan, although the latter was the sole underwriter.

More importantly, however, Firstsource was initially set up as a back office services unit of ICICI and while it obtained a listing in its own right in February this year, the bank still owns 25% of the company.

ôThe fact that a 25% owner of the company was willing to stamp its feet and say the credit is really at this level made investors very comfortable almost immediately,ö says a source.

Firstsource, which is the third largest pure play BPO company in India, also has other well-known investors among its shareholders, including SingaporeÆs Temasek Holdings. The triple-A rated investment company holds 21% of Firstsource and this added further to investor confidence. However, investors werenÆt going to agree to just any terms as evident by the fact that both the conversion premium and the yield were fixed at the most generous end of the indicated ranges, from the investorsÆ point of view.

The deal was offered with a conversion premium between 35% and 40% over TuesdayÆs volume-weighted average price of Rs68.3654 on the National Stock Exchange of India and priced at 35%. Similarly, the 6.75% yield was set at the top of a range starting at 6.5%.

Aside from the credit, the underlying assumptions included a 5% stock borrow cost, a full dividend pass-through in year one and compensation for any dividend above Rs1 per share from years two onwards. Based on the current share price, this translates into a 1.5% dividend yield after the first year, or 1.2% adjusted for the five-year period.

Together with the pricing, this gave a bond floor of 92.9%, which is quite low for a 35% premium. This is especially true considering that the implied volatility was a rich 31.5% compared with a 100-day volatility of 38% and a 30-day volatility of 36%.

Still, investors bought and the bookrunners were able to complete the deal in only a couple of hours. Sources say the offering was a few times subscribed with 40-50 participating accounts. Liquidity in the stock is very light with only about $1.4 million worth of shares traded each day on the National Stock Exchange and the Mumbai bourse combined, based on the three-month average daily volume. This means the CB accounted for more than 190-days trading volume and provided a rare chance for investors to buy into the stock in size.

However, while investors say they believe in the equity story and the acquisition strategy, the share price has been on a declining trend after climbing close to Rs85 shortly after the announcement of the MedAssist takeover in late August. This has remained the case even after the company said two weeks ago that its net profit increased by 143% to Rs456 million ($12 million) in the quarter to September 30 versus the corresponding quarter in 2006. Compared with the previous quarter, the net profit rose 2.9%.

One reason for the recent drop û the stock had fallen for eight days straight when the bond issue was launched on Tuesday this week û could be the reports in the local media saying Firstsource has lost out to larger BPO rival Genpact in the bid to take over CitiÆs captive BPO business. However, some observers expressed relief that Firstsource hadnÆt won given that the transaction would have come so close on the heels of the $330 million MedAssist acquisition, which is already quite large in relation to the companyÆs existing operations. For one it will boost the companyÆs current revenues by close to 50%.

Either way, the share price hasnÆt performed, falling about 21% from the earlier mentioned high in early September and 28% from the all-time closing high of Rs92.05 in mid May. The declines have taken the share price close to the IPO price of Rs64, making the equity story seem a bit less convincing û at least on paper. In the two days since the CB transaction the shares have lost another 3.8%.
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