Gap between issuers and investors makes new CBs a challenge

Investors have cash to invest but prefer convertibles and exchangeables from high-quality names like Temasek. Other issuers need to offer investor-friendly terms and asset swaps to get their deals out the door, sources say.
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Barclays: Weakness in supply of CBs poses a challenge to investors
<div style="text-align: left;"> Barclays: Weakness in supply of CBs poses a challenge to investors </div>

As Asia gradually returns from the lunar new year holidays this week and next, market participants are hoping for a revival of the region’s equity capital markets. Deal activity in the last three months of 2011 reached only $28.4 billion, which is the lowest quarterly volume since the first quarter of 2009, and the start to this year has also been lacklustre. Excluding deals smaller than $100 million, there have been only three block trades, one top-up placement and one convertible bond.

This is perhaps not too surprising as the lunar new year fell early this year, but there is a worry that there are other reasons for the slow start to 2012, such as the continuing crisis in the eurozone and the fact that share prices are not at a level where issuers and existing shareholders want to sell. And with a general expectation that the equity markets will remain quite flat in the first three to six months this year, there is also no real urgency among investors to buy unless the price is cheap.

This gap between what issuers want and what investors are prepared to pay is particularly evident in the equity-linked market. Traditional convertible bond investors like hedge funds are sitting on a lot of cash after the fourth quarter of 2011 offered few buying opportunities and are keen to see more new issues. However, they are also highly selective about what kind of deals they want to invest in. Specifically, they want low-risk deals that allow them to hedge both the equity option and the credit, and they prefer higher-rated credits or blue-chip names. Unrated or non-investment grade mid-cap names, particularly from China, are out of favour and zero-coupon issues are also viewed as a challenging sell. In other words, investors aren’t really interested in the companies that are most in need to raise money.

The importance of asset swaps — and the difficulty in obtaining them — was made abundantly clear earlier this month when Taiwanese hardware manufacturers Wistron and Pegatron both tried to put together CBs of about $250 million to $300 million. Typically, outright investors don’t care too much about asset swaps as they buy CBs for the equity story and don’t tend to hedge the credit, but lately they too have wanted to see asset swaps on deals. The reason, CB specialists say, is that they know there will be less demand from hedge funds if there aren’t enough asset swaps upfront and they worry that this could translate into a weaker performance in the secondary market too.

At the same time, Taiwanese banks are currently not that keen to provide asset swaps in US dollars, and anything longer than three years is out of the question altogether. One reason, bankers say, is that a lot of their dollars are being lent to Taiwanese companies in mainland China, which have trouble getting loans from domestic Chinese banks. And international banks are cautious about taking on the risk, especially since swap spreads have been widening significantly during the past year.

After more than a week of negotiations Wistron finally managed to get its CB out, but only after the deal size had been significantly reduced to match the availability of asset swaps. The Pegatron CB has yet to hit the market.

As reported earlier, Wistron raised $180 million through a three-year deal that comprised a $150 million base offering, which was 100% covered by asset swaps, and a $50 million upsize option that was partially exercised. It also came with a $100 million greenshoe that can be exercised before February 2. The latter was unusually large and was said to have spooked investors somewhat since there were no asset swaps to cover that part of the transaction at the time of the issue. However, one source said more asset swaps were expected to be available in the market later on as some domestic banks wanted to see how the issue was trading in the secondary market before committing. The arrangers will exercise the shoe only if more swaps materialise, the source said.

According to sources, the CB was bid just below par in the week leading up to the lunar new year holidays.

Aside from Pegatron, there are a few other Taiwan CBs in the pipeline, including Far East International Bank that filed for a deal last year, but has yet to hit the market. Sources say the deal has got delayed partly because of the eurozone debt crisis, which has dented the confidence in banks in general, partly because the share price is well below the level where the issuer would consider a sale.

The pipeline also includes at least two Indian names, both of which are good tier-1 credits that should be able to find buyers even though the Indian stock market remains depressed, bankers say. However, most of the small and mid-cap Indian issuers with CBs that mature this year are not expected to be able to refinance the bonds in the CB market; in fact, many of them has seen their valuations drop so much that their outstanding CBs are now larger than their entire market cap.

Speaking to CB bankers and investors over the past few weeks, there seems to be a general consensus that the next few deals that hit the market will have to offer quite investor-friendly terms and issuers that keep insisting on zero coupons and zero yields may have a hard time to find buyers.

What CB investors really want, though, is more deals by high-quality issuers like Temasek, where they don’t really need to worry about the credit. For such issuers they are quite happy to accept no coupon and even a relatively high premium. Temasek, which is controlled by the Singapore government, used to be a rare issuer in the equity-linked market but in the fourth quarter last year it brought two deals, taking advantage of the cheap money available to it in this market.

Because Temasek isn’t listed, its equity-linked deals are exchangeable into other companies in its large portfolio — typically high-rated companies that allow for aggressive terms. The first transaction in mid-October, which was Temasek’s first since 2004, was exchangeable into Standard Chartered shares and saw the company raise S$800 million ($632 million). The three-year deal came with a zero coupon and yield and a 27% exchange premium, and attracted S$1.25 billion of demand.

The second deal came in December, raised S$500 million and was exchangeable into shares of Li & Fung, a Hong Kong-listed supply chain manager and sourcing company. This bond also had a three-year maturity and a zero coupon and yield, but came with a higher exchange premium of 40.165%. It was about 2.5 times covered.

According to sources, Temasek is pondering the sale of one more exchangeable bond in the near-term. And while this will reduce the rarity factor of the company’s other exchangeables, there is expected to be ample demand for at least one other transaction, the sources say.

A similar high-quality issuer that is said to be considering an exchangeable bond is Malaysian sovereign wealth fund Khazanah Nasional. The fund has previously issued exchangeable bonds, including three Shar’iah-compliant sukuk exchangeables, but the last such deal came in March 2008 when it sold $550 million of bonds exchangeable into Hong Kong-listed department store operator Parkson Retail Group. If it chooses to revisit the market in the next couple of months, it too is bound to attract good demand from investors hungry for good-quality paper, sources say.

Aside from the two Temasek-backed deals, only two other convertible bonds were issued in Asia ex-Japan in the fourth quarter and together they raised only $230 million, leaving investors starved for investment opportunities. According to data provider Dealogic, equity-linked issuance in the region in 2011 as a whole amounted to $19.7 billion, which was down from $26 billion in 2010, but up from $12.7 billion in 2009. These numbers are somewhat inflated, however, by the fact that they include CBs issued in China’s domestic market. Last year, for example, Sinopec sold $3.5 billion worth of bonds convertible into its Shanghai-listed A-shares and China Shipping Development raised $625 million from the sale of a similar domestic CB. These deals are difficult for international investors to participate in since they can only buy the bonds through existing qualified foreign institutional investor (QFII) quotas, which are still quite limited.

In a global convertible outlook for 2012, analysts at Barclays Capital noted that positive drivers for new CB issuance in Asia this year include the refinancing of existing CBs in coming years, as well as the long-term growth and financing requirements in countries like China.

In terms of risks, the report argued that macro concerns remain the primary risk to the convertible asset class: “Convert performance largely hinges on the economic recovery, greater certainty around policy actions, resolution of the European sovereign crisis, clarity around regulatory requirements for the financial sector and the allied performance of equity, credit and government bonds.”

And on top of that, “the continued weakness in supply of new paper poses a challenge to investors, should a pickup fail to materialise”.

Barclays estimates $15.4 billion of redemptions in Asia-Pacific this year, which would require $1.3 billion of issuance every month just to achieve a flat annual supply. But as noted earlier, many of the redemptions in India are not expected to be refinanced via new CBs.

“In addition, liquidity will likely remain on top of investors’ minds, especially in light of the severe liquidity contraction experienced in the corporate debt markets,” the Barclays report said.

¬ Haymarket Media Limited. All rights reserved.
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