Fu Ji Food issues tasty second convertible

A positive response from investors to Fu Ji's second CB within a year allows the three year deal to be increased by 25% to $128 million.
Fu Ji Food & Catering became the fifth Asian company to issue convertible bonds in two weeks when it raised HK$1 billion ($128 million) from an upsized offering late Monday.

While the investor response to the various issues has been somewhat mixed, the increased frequency of the deals suggest that issuers are becoming happy with share price levels again. Market participants are now watching for the next Indian CB following a five-month long drought in the wake of the global equity market correction in May, during which only one convertible above $100 million has hit the market.

Fu Ji Food was launched on a day when the Hang Seng Index recorded its biggest drop in nearly two weeks and Asian markets were generally lower amid news that North Korea had conducted a nuclear test. The companyÆs own share price also dropped 2.1%.

Investors turned out to be very keen on the companyÆs Hong Kong dollar-denominated bonds, however, with the initial size of HK$800 million being covered about four times. This enabled sole bookrunner UBS to immediately exercise the HK$200 million greenshoe.

Fu Ji Food, which is the largest provider of catering services in Shanghai, had a good track record to build on as it issued HK$600 million worth of CBs through JPMorgan a year ago, which thanks to a low conversion premium and a strong share price performance, have already been about 85%-90% converted to equity.

The new bonds were somewhat unusual in that they will mature in only three years, although from an investor point of view this probably makes little difference compared to the more common structure with a five-year maturity and a three-year put, since they tend to value convertibles based on the put date anyway. The companyÆs previous CB used the latter structure, but this time it wanted the bonds to be as simple as possible, according to a source close the deal.

More common features included a zero coupon and an issue price at par to the face value. Two of the five CBs issued recently have, however, been re-offered below par to accommodate tight pricings.

The yield was fixed right at the bottom of the 5.75% to 6.25% marketing range, while the conversion premium was set at 26% over MondayÆs close of HK$13.90 after being offered between 22% and 27%. The fact that both the yield and the conversion premium were pushed towards the extreme end came as a bit of a surprise to some observers, especially since the bookrunner provided no credit bid, but with virtually no price sensitivity in the book there was no point in holding back.

Indeed, the bonds, which were bought by about 45 investors, traded up in the after-market on Tuesday and were quoted at par to 100.75% late in the afternoon.

The company would have been pleased with the pricing which made the deal somewhat less equity-oriented than last yearÆs smaller CB. That issue also achieved a 5.75% yield, but had a conversion premium of only 13.5%.

The assumptions on the new bonds included a credit spread of 350 basis points over Hibor, a dividend yield of 1.5% and a stock borrow cost of 5%.

This gave a bond floor of 93.8% and an implied volatility of 28.8%, which is higher than usual for a bond with this short a maturity. However, the 100-day historic volatility is also very high at 48% and since there is no lending of the stock, investors wonÆt be able to capture the volatility anyway, notes one observer.

The bonds will redeem at 118.54%, but carry an issuer call after 1.5 years to speed up the conversion to equity, subject to a 130% hurdle.

The fact that this is a fast-growing company and a China concept stock in the ôhotö retail sector obviously played a key role in attracting investors to the deal, but the outlook has become somewhat more muddled after the share price reached a record high of HK$20 in February this year. Having rallied 545% from its December 2004 IPO up to that point, the stock has recorded a 30% decline in the past eight months.

The five analysts following the stock according to Bloomberg Data also have a very mixed view on the companyÆs future prospects with target prices varying sharply from HK$11.50 to HK$21.

Kim Eng Securities, which is the most negative of the lot, argues in an August research note that Fu Ji FoodÆs well above-average margins are unsustainable, especially since the company is increasingly focusing its catering business towards clients at the low end of the market, such as schools and state-owned enterprises.

However, in the first three months of its fiscal year to April 2007, the company posted a 51% increase in net profit to Rmb77.1 million on a 56% rise in turnover to Rmb242 million. The gross profit margin narrowed only slightly to 54.9% from 55.6%.

Catering services saw a massive 82% surge in revenues and increased in importance to account for 74% of total turnover, compared with 63.7% a year earlier. The group said it is expanding these services outside its main business area in the Yangtze River Delta to take advantage of a growing trend of companies outsourcing their food service to contract caterers in order to cut costs. Its main focus in this respect is on Beijing and the coastal regions with large worker populations such as the Shandong Province and the Pearl River Delta.

According to the term sheet, proceeds from the bond issue will be used primarily to expand the capacity of the groupÆs existing sourcing and initial processing centres (SIPCs) in Linqu and Shougang in the Shandong Province and in Ningbo in the Zhejiang Province. It will also help pay for a new SIPC in Wuxi in the Jiangsu Province.

UBS muscled its way into the arranger role for the CB after doing a lot of work with the company since JPMorgan did the previous bond issue at the end of September 2005, including taking the management on a non-deal roadshow to meet more international clients. While Fu Ji Food has grown substantially in size since the IPO, the investment bank is no doubt also fishing for more future business as contract catering tends to be a capital intensive business.
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