First Pac back with PLDT exchangeable

Hong Kong holding company surprises capital markets with daring exchangeable into Philippines dominant telco PLDT.

The completion of an upsized $198 million exchangeable into Philippine Long Distance Telephone Company (PLDT) yesterday (January 11) may signal that First Pacific is back on the acquisition trail again.

With an order book that closed three times covered, the deal is also likely to be viewed as a huge success. This is because it shows just how far the First Pac group has been able to transform its fortunes since 2002 when it was embroiled in a major liquidity crisis and very public spat between its major shareholder, Anthoni Salim and executive chairman Manny Pangilinan.

Nevertheless, the UBS-led deal still ranks as one of the most ambitious high yield equity-linked offerings of recent years and demonstrates just how far investors are now willing to move down the credit curve. The lead's major challenges were selling the credit of a holding company with a history of cash flow problems and the equity of an emerging market stock that only trades about $4 million a day, because it is listed in a country where liquidity has completely shrivelled up and the government is facing an imminent credit downgrade from Moody's because of its ballooning budget deficit.

Indeed, there has not been an equity-linked from the Philippines since the summer of 1998 when First Philippine Holdings completed a $36 million offering.

Terms of First Pac's deal comprise a five-year maturity, with an issue price of par, zero coupon and redemption price of 131.97% to yield 5.625%. The deal was marketed on a yield of 5.125% to 5.625% and redemption price of 128.79% to 131.97%.

The exchange premium was also set at the low end of the indicative range and was fixed at 21% to the stock's Ps1,360 close in Manila on Tuesday. It had been marketed on a 20% to 25% range.

There is also a call option in February 2008 with a 130% hurdle and a put option in February 2008 with a put price of 118.11%.

Underlying assumptions comprise a bond floor of about 93%, implied volatility of 25% to 26% and theoretical value of 100% to 102.8%. This is based on a credit spread assumption of 425bp over Treasuries, 1% borrow cost, 2.4% to 3.1% dividend yield and volatility assumption of 26% to 30%.

Pinpointing a valuation is complicated by a number of factors. Firstly there are no clear credit comparables although the group does have an illiquid, collateralised eurobond outstanding - CAB Holdings $115 million 8.25% July 2006 bond, which is currently yielding about 7%. This deal, completed last summer by UBS, has a single B rating from Standard & Poor's and is backed by First Pac's stake in Indofood.

Secondly PLDT has not as yet confirmed that it will actually start re-paying dividends in 2005 and therefore analysts can only guess what the prospective pay-out ratio might be. Thirdly, the company is making borrow available, but only for its domestic shares and not against the ADR's, which trade about $5 million a day.

About 60 investors are said to have participated in the deal, which was upsized from $150 million to $198 million. There is no further upsize option.

The book is said to have been pretty evenly split between hedge and outright investors. No asset swap took place in the primary market, although specialists believe there is likely to be some follow-on credit demand from the Philippines.

One of the stand-out aspects of the transaction is its lack of a cash coupon, the omission of which says much about the driving force of First Pac - cash flow (lack of). By stacking up the interest payments at redemption, First Pac hopes to alleviate the burden on its cash flows, which it has been painstakingly trying to re-build over the last two years.

First Pac is owned by Indonesia's Salim family, which has a 44.5% stake. The company has three major assets: a 24.3% stake in PLDT, a 51.6% stake in Jakarta-listed Indofood (the world's largest instant noodle manufacturer) and a 75.5% stake in Metro Pacific Corporation (MPC), its troubled property arm. Indeed it was Pangilinan's ambitions to create a property empire via the purchase of the Bonifacio Land Corporation at the time of the financial crisis, which almost proved to be the group's undoing.

In order to meet First Pac's subsequent debt obligations the Salim family attempted to sell their stake in PLDT to the Gokongwei family in 2002. However, the deal was blocked by PLDT's CEO Pangilinan after he invoked a "competitor by-law", which prevented its sale to a competitor. The Gokongwei's owned Digitel.

As a result of the bizarre debacle, which saw the operating company (PLDT) sue the holding company (First Pac), the latter was forced to issue a high yield bond backed by its stake in Indofood. However, this was still not enough to cover First Pac's cash flow requirements and it went on to sell its other remaining asset - Indian phone company Escotel in January this year for $15 million.

Yet Pangilinan appears to have been vindicated over the long run and has certainly continued to be tolerated by Salim who allowed him to continue on as First Pac CEO. In First Pac's 2002 Annual Report, Pangilinan said that, "relinquishing control over our telecoms investment at a time when it was clear that profits and cashflow were about to accelerate gave me pause."

Since then, PLDT's share price has rocketed as the company has been able to escape its debt trap by using the huge cash flows generated by its fast expanding cellular arm, SMART. As a result, debt to EBITDA has dropped from 4.24 times in FY01 to 2.04 times as of 1H04.

In the summer of 2002, the Gokongwei's offered to buy the PLDT stake at Ps1,131 a share - a 260% premium to its then share price of Ps430. After the deal fell apart, PLDT's share price crumbled and was back trading at Ps200 by year-end.

One year later, however, and it had quadrupled to Ps800. Over 2004 it continued its spectacular climb, reaching a high of Ps1,400 around year-end.

Analysts now have a fairly neutral view on the stock and have highlighted a number of concerns that may impede future performance. Specifically, they wonder where future upside potential is coming from and believe that SMART may be coming under ARPU pressure. There is also a possibility that the beleaguered government may impose a windfall tax on the telecoms operators to help plug the national deficit.

Ironically, some analysts now believe the biggest upside potential lies at First Pac itself. The company's share price performance is said to have lagged PLDT, although it too has performed well over the past year.

Pre financial crisis, First Pac had traded as high as HK$12. At its low, it fell to HK$0.69.

Come the launch of its high yield bond of July 2003, the stock was back at HK$1.40. Currently it is trading at HK$2.15 and analysts now have price targets around the HK$3 level.

First Pac's upside potential is being driven by the prospects of new acquisitions and its ability to meet its cash flow requirements through increased dividend payments. Analysts calculate that First Pac may get about $20 million in dividend income in 2005 of which half will come from PLDT (10% pay-out ratio) and half from Indofood.

In 2004, Indofood paid its parent a $13 million dividend based on a 30% pay-out ratio. In addition, First Pac earns about $8 million to $10 million per annum in management fees from SMART.

Its outgoings comprise $9.3 million in annual interest payments for the CAB bond and $2.6 million in interest payments for a $55 million loan collateralised by PLDT shares. This falls due in September 2006, although the company pre-paid $23 million earlier this year.

Head office also incurs annual running costs of about $7 million to $8 million.

In a research report published late last year, UBS calculated that First Pac had managed to accumulate a cash balance of $78.3 million and that the market value of all its equity stakes covered the parent's debt by a ratio of 10 times.

In terms of debt ratios, the holding company saw debt to EBITDA drop from a peak of 5.15 times in 2002 to 3.85 times at the beginning of 2004.

Now that First Pac is in a position too meet all its interest payments and running costs, the group appears to be taking a much more active approach to future investments. Specialists say that some of the proceeds from the exchangeable are likely to be used to pre-pay more debt and make its liquidity position a little more secure.

But the large size of the transaction will prompt renewed speculation that it wants to expand. It recently bid for Indonesian cellular operator Excelcomindo (just losing out to Telekom Malaysia) and company officials have said that they are also looking at power and toll road assets in the Philippines.

Investors are therefore, likely to be gambling that a sounder financial footing will generate an upgrade by the rating agencies, a re-rating of the stock and a high return at a time when the company has reached a positive inflexion point.

Share our publication on social media
Share our publication on social media