Glenmark CB: coming up roses

Indian pharma company introduces new CB structure to Asian equity markets.

Glenmark Pharmaceuticals completed a $70 million convertible on Monday. The deal was small in size, but highly innovative through its adoption of forward re-sets in a structure dubbed ROSES (Resettable Onward Starting Equity-linked Notes) by its lead manager JPMorgan. It was also extremely lucrative for the bank, netting the lead 3% in fees and a mandate that had once been held by Merrill Lynch.

The global equity-linked market is more used to downward re-set than upward ones, but in this instance a structure was devised to cope with India's unusual regulatory requirements concerning minimum maturities. The government's stipulation that CBs must have a minimum maturity of five years makes life difficult for high growth companies like Glenmark, which believe they risk giving away too much equity upside through a standard equity-linked structure.
Glenmark's deal had two tranches. A $20 million Tranche A had a plain vanilla structure and was priced at par, with a zero coupon five-year bullet maturity and redemption at 133.74% to yield 5.9%.

The conversion premium was fixed at a record breaking 71% to the stock's VWAP on Monday. Glenmark closed the day up 2.6% at Rs504.4. The deal also has a three-year call with a 130% hurdle.

A $50 million tranche B was also priced at par with a zero coupon five-year bullet maturity and redemption at 134.07% to yield a slightly higher 5.95%.

But the deal cannot be converted until the 22nd month (November 15 2006) at which point it will have a 35% premium to the average stock price of the past two trading months (ie the 20 and 21st months). By using this structural twist, Glenmark gets to keep any stock price upside over the next two years and it believes this could be considerable since management have told investors they expect the stock price to double or triple over that period.

Should this scenario not play out, investors will be protected through a minimum floor price of Rs500. This means that should the stock not perform, investors will get to own a three-year deal with a zero premium, which would still be attractive in the context of most Asian CB's which have much shorter two to three year maturities.

Tranche B also has a slightly different call option, which can be exercised in four years at a 130% hurdle.

The deal is said to have attracted orders totalling $350 million, although it was not really marketed and placed with a core group of 15 targeted investors. Most investors participated in both tranches and 85% were from Europe.

Underlying assumptions comprise a bond floor of 98.2% for tranche A and 98% for tranche B, implied volatility of 27% for tranche A and 26% for tranche B, with theoretical value of 101.5% for tranche A and 101.25% for tranche B.

These assumptions are based on a credit spread of 210bp over Libor, 5% borrow cost, 0.26% dividend yield and 30% volatility assumption. Specialists say the stock's 100-day volatility currently stands at around 55% but is expected to decline.

Glenmark has had a phenomenal 12 months with its stock price soaring from a low of Rs127 to a high of Rs527. In the last four months it has risen 183% and is currently trading on a 2005 P/E valuation of 19.5 times earnings. This would place it in line with a similarly sized pharma company such as Wockhardt, which is currently trading at 19.7 times. Glemark has a $600 million market cap versus $850 million for Wockhardt.

Share price performance has been driven by news of a collaboration agreement with Forest Laboratories in the US. The latter will develop an asthma compound developed by Glenmark and could pay licensing fees of up to $190 million over the next five years. The company says this is the highest licensing agreement ever struck by an Indian pharma company.

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