The private equity firm sold $155 million worth of shares, or just over half its stake as part of the offering, which brought the total value of the combined equity and CB transaction to $942 million. GomeÆs part of the transaction was split into a $187 million share placement and a $600 million renminbi-denominated zero-coupon CB, which has a seven-year maturity with two put options at years three and five.
The CB, which is already the largest ever convertible done by a non-state-owned Mainland company, has a greenshoe which could boost the size of the bond issue to $650 million and the total proceeds raised by the company on Friday to $837 million.
The deal came a day after market leader Gome posted strong first quarter results, which prompted several international investment banks to upgrade the company. The stock was already on an uptrend, however, having risen a hefty 61% since April 11. It has set a series of record closing highs in that period, including FridayÆs HK$14.20.
The 2006 earnings report, which was better than expected on the back of GomeÆs acquisition of rival China Paradise last year, has been an important factor in those gains, but the stock has also received a lot of attention from the international investment community after Goldman Sachs took the company on a global non-deal roadshow for a couple of weeks last month. The US investment bank was also the sole bookrunner for all three legs of this transaction.
The rapid share price gains would have made the sale of new shares a bit of a challenge, and it didnÆt come as a big surprise that the deal priced towards the bottom of the offering range for a 6.3% discount to FridayÆs close. The shares were offered at a price between HK$13.25 and HK$13.68 and priced at HK$13.30. What made the deal seem really aggressive, though, was the fact that the CB was launched with a fixed conversion premium of 50%.
Among Hong Kong-listed companies, that high a premium has previously only been achieved on three equity-linked deals: a HK$1.5 billion CB by Hengan International Group, which had a five-year maturity and a three-year put; the $500 million exchangeable into China Overseas Land & Investment (CLOI) last month, which had a seven-year maturity, five-year put structure; and on Sinopec's $1.5 billion Hong Kong-dollar-denominated CB with a seven-year maturity, four-year put structure. The latter was completed the day after the CLOI deal.
However, Gome saw solid demand both for the bonds and the equity portion with about 50 investors buying into each tranche, sources say.
ôQuite a few people who met with the company at the roadshow and then saw the results were looking for an opportunity to get in,ö one of them notes.
Both tranches were offered with a $100 million size range to give the bookrunners some flexibility on allocation depending on the demand. In the end, it decided to sell the maximum amount of shares and to keep the size of the CB in the middle of the range, which met the companyÆs intention to raise between $800 million and $850 million (including the shoe).
ôFrom a corporate finance perspective this makes sense. The company is growing fast and wanted an aggressive structure, but not so aggressive that it would put it at risk in a possible downturn,ö says one observer.
With 12 CBs of size issued over the past month, the management was also said to have been conscious not to stuff the market with too much paper as it wanted the bonds to trade well in the aftermarket. Especially, since it has spent a lot of effort on improving GomeÆs reputation both with regard to corporate governance and the quality of its business.
According to one market source, the bonds were both bid and offered at around par in the grey market on Friday. The real test will come as the shares start trading today, though, after being sold at a discount through the placement. The most recent three Hong Kong placements, which were all from the real estate sector, have traded down from their respective placement prices, but there is a chance that the current strong momentum for the Gome shares will be enough to offset any placement-related selling.
At the final size, the equity placement (including the Warburg Pincus portion) was about two times covered with very little price sensitivity û although that may have been due to people expecting Goldman to do the right thing and price towards the bottom anyway given the recent rally. The interest out of Europe was said to have been particularly strong and one source said as much as 40% of demand may have come from there, with another 40% from Asia and the rest from the US.
The CB attracted 1.5 times the necessary demand, including some quite large orders of about $25 million each, sources say. Given that outright equity investors had the opportunity to buy into the equity tranche, the bulk of the demand for the bonds came from CB specialist investors. Some investors participated in both tranches, however.
ôThere has been a lot of CBs recently, but many of them have been real estate-related so investors are quite happy to get exposure to a different sector,ö one observer notes. Being a retail chain, Gome also grows more directly in line with ChinaÆs rapidly expanding GDP and retail sales (than property companies) and the acquisition of China Paradise has give it the necessary scale to make the most of that growth, he adds.
Aside from the 50% conversion premium, which was fixed over the discounted placement price of HK$13.30 for a conversion price of HK$19.95, the bonds were also offered with a fixed yield of 0.75%. There is no yield step-up, but CB specialists said the fact that there is a second put option does make it much more likely that investors wonÆt sell the bonds back after three years. If correct, that would mean the company has been able to secure five-year funding at a 0.75% interest, which must be considered a very good outcome û assuming that the bonds have not been converted into equity by that stage.
There is an issuer call after three years to encourage conversion if the share price continues to perform strongly. The call is subject to a 130% hurdle. The bonds arenÆt convertible for the first year, but at any time after that.
Investors were told the size of the CB may range from Rmb4.2 billion to Rmb5 billion ($547 million to $651 million) plus a greenshoe of Rmb400 million ($52 million). The final size was fixed at Rmb4.6 billion, or about 7.5% of the company if fully converted, with a maximum greenshoe. The bonds will be settled in US dollars.
The number of shares sold by Warburg Pincus was fixed at 90.9 million, but the companyÆs top-up placement was offered in a range of 55 million to 110 million shares. The 110 million that it ended up selling account for about 3.5% of the enlarged share capital (not counting any shares that will have to be issued to cover the CB). Chairman Wong Kwong Yu who put up the existing shares for sale before subscribing to the same amount of new shares at the same price will see his stake in the company fall below 50% from 51.2% as a result of the dilution.
Warburg Pincus is selling down its stake to 2.8% from 5.78% prior to this deal. The private equity firm has made a significant profit on its initial $128 million investment which it acquired through five-year convertible bonds and warrants back in February last year. The CB had a conversion price of HK$6.40, which, means even on an unleveraged basis it has more than doubled its money already.
However, the US-based firm wonÆt be severing its strategic partnership with Gome and will be keeping its seat on the board û even though its remaining stake is no longer regarded as substantial and it doesnÆt have to disclose any further sell-downs. This should come as a relief to investors who saw Warburg PincusÆ investment into Gome as a starting point for a much needed improvement in corporate governance practices and more transparent communications with its shareholders.
However, with better practices now in place, Warburg PincusÆ actual shareholding in the company has become less of an issue, sources familiar with the company say.
The valuations of the CB included a 95.5% bond floor and an implied volatility of 30%, which is well below the 100-day volatility of 49% - although the volatility has spiked in recent days as a result of the sharp share price gains. These valuations assume a credit spread of 200 basis points above Libor (on a three-year basis), a full dividend protection and a 3.5% stock borrow cost. Goldman provided asset swaps for $100 million to $150 million, or up to a quarter of the base deal size, which was believed to have been taken up in full.
Gome posted a 75% rise in its first-quarter profit to Rmb169.2 million ($21.9 million) from the same period a year earlier, supported by the China Paradise acquisition.
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