Formosa scores a cracker?

Taiwanese petrochemicals group completes giant equity-linked deal.

Lead manager Goldman Sachs appears to have pulled off one of the trickiest deals to execute so far this year - a four headed convertible and exchangeable by Taiwan's Formosa group.

Convertible specialists say terms on the $800 million deal priced yesterday (Monday) were not expensive. But the size was a major problem. Should the $200 million greenshoe be exercised, the $1 billion deal will rank as the largest equity-linked deal from Taiwan on record.

More importantly, it has come at a time when Asian CB investors are sitting on large losses from earlier transactions and have not been showing much inclination to participate in the primary market no matter how attractive terms might seem on the surface.

However, even non-syndicate bankers acknowledged the four tranches of the deal were trading up a quarter to three quarters of a point once the deal broke syndicate last night. Many considered this quite an achievement given the deal had been quoted below par in the grey market during the three day run up to pricing. A number concluded the bonds must have been tightly locked away somewhere since little paper was seen floating around the secondary market and few credit bids were getting hit.

The deal was prompted by the Formosa's group desire to increase the freefloat of Formosa Petrochemicals Corp, which listed on the Taiwan Stock Exchange last December. At $12 billion, the company has one of the largest market caps on the exchange. However, its freefloat is officially only 2.3%, although up to 10% of issued share capital is said to be have become available since listing.

On full conversion, the new deal will potentially triple the group's official freefloat and Formosa group companies will see their shareholding drop from 85% to 79%. Under Taiwanese law, the IPO shareholders are subject to a one-year lock-up, so opted for an equity-linked structure as a good way to monetize their holdings and take advantage of low interest rates while they still could.

As such they put together a structure with a high degree of equity sensitivity including a long final maturity, low conversion premium, re-sets and full dividend protection.

The four tranches of the deal comprise a $200 million convertible by Formosa Petrochemical and three $200 million exchangeables into Formosa Petrochemical by Nan Ya Plastics, Formosa Plastics and Formosa Chemical and Fibre. Terms on all four deals are exactly the same, although the convertible has a one notch lower rating of BBB compared to a BBB+ rating on the three exchangeables.

All four tranches have seven-year final maturities and put options in years two and five. There is also a two-year call subject to a 120% hurdle.

The four were priced at par, with zero coupons and redemption at 103.6% to give a yield of 0.5%. The two-year put was priced at 101% and five-year put at 102.5%.

The conversion premium was set at 10% to the stock's NT$53 close. This represented the low end of a 10% to 20% range. The first re-set kicks in this December and annually thereafter.

Underlying assumptions comprise a bond floor of 92.85%, implied volatility of 19.4% and theoretical value of 105.9%. This is based on a credit spread of 100bp over Libor, full dividend protection, 6% stock borrow assumption and 30% volatility assumption.

The four books are said to have averaged an oversubscription rate of two times, although the convertible was slightly more popular since it becomes convertible immediately, whereas the exchangeables are restricted until December because of the IPO lock-up rules.

About 60 accounts are said to have participated in total. Such a small order book for such a large deal is said to have prompted some very full allocations. The high rating of the Formosa group also meant that asset swap demand was strong among the hedge funds that participated.

However, supporters say hedge funds played a much smaller role in this deal compared to most Asian equity-linked offerings and this was the key to its success. Instead of completing the deal via an accelerated book-build that would appeal to momentum-driven accounts, the lead marketed it over three days in the hope of capturing a much wider investor base.

Sending the company out on roadshows was an unusual step, but specialists say it was an important branding exercise given it only listed six months ago. One specialist comments, "Foreign ownership of the stock is barely 1% and it only trades about $15 million a day so it's been very difficult for institutional accounts to build any kind of position. The roadshow gave them an opportunity to get to know the company, while the deal allowed them to buy into it in size.

"There are very few direct plays on the petrochemicals industry in Asia," he adds, "and this deal enabled investors to diversify away from the tech and bank stocks, which normally constitute issuance from Taiwan. "

As a result, observers say hedge funds accounted for only 50% of the final allocation, with long-only equity investors taking 25% and fixed income funds the remaining 25%.

Other bankers were more sceptical, arguing that a number of accounts were concerned about share price performance and a potential downturn in the petrochemicals cycle. Since listing the company has risen 24%, while the Taiwan index is down 1%. Formosa Petrochemical is currently trading at about 14.5 times 2004 earnings compared to about 13.1 times for its nearest comparable, India's Reliance Industries.

Alongside Goldman, ABN AMRO and Citigroup were joint leads, no books, while Capital Securities was co-manager.

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