Hang Lung develops new CB sector

Asia''s first public convertible bond denominated in Hong Kong dollars shows CSFB''s innovative touch.

Continuing to build on its reputation for market leading transactions, the bank has issued an increased HK$2 billion ($257 million) offering for Hang Lung Properties, formally known as Amoy Properties. The speed of execution and size of transaction achieved are also all the more remarkable for the fact there have only ever been two small privately placed issues in Hong Kong dollars before, both issued a decade ago.

Having been awarded a mandate on Tuesday evening, the bank completed the deal within the space of 40 hours, with books closing five times oversubscribed. As a result of the strong demand and the borrower's desire to achieve size over aggressive pricing, the deal was increased from HK$1.5 billion to HK$2 billion, with the addition of a HK$250 million greenshoe.

To compensate investors for the unusual currency element, observers say it was important to keep the deal structure as simple as possible. They add, however, that the strength, stability and longevity of the HK$/US$ peg, meant that most investors saw the currency as something of a non-issue.

Nevertheless, the five year issue, in the name of Top Invest Finance Ltd, has a clean par in par out structure, with a cash coupon of 3.4% and conversion premium of 11.1% to the stock's HK$8.10 close (Thursday). This represents the wide end of the coupon range (2.9% to 3.4%) and mid point of the premium range (9% to 14%). There is also hard no-call for two years thereafter subject to a 115% hurdle and a three-year put at par to yield about 60bp through four-year Exchange Fund notes, roughly 4% bid at the time of pricing. There is no other syndicate.

Underlying assumptions comprise a bond floor of 93.9%, theoretical value of roughly 105% and implied volatility of 23%. This is based on a credit spread of 120bp over Hibor, dividend yield of 5.1%, 250 day volatility assumption of 34% and 500bp stock borrow cost.

Because of the hugely liquid credit market for Hong Kong names, the fixed income element of the issue was easy to value in comparison with notoriously untransparent Taiwanese market, which accounts for most CB issuance in the region. Analysts add that although Hang Lung is unrated, it has an implied BBB+/Baa1 rating in line with Hysan Development, which issued a $200 million 10-year fixed rate bond at 200bp over Treasuries towards the end of January. Currently trading at 176bp bid, to yield 6.8%, the deal was led by Merrill Lynch and Morgan Stanley.

But observers add that a relatively high bond floor reflects a stock that has little volatility and virtually no borrow. "There's not much juice to be had from the valuation because this isn't a hugely volatile stock and an existing perpetual preferred issue for Amoy Properties has eaten up most of the borrow," one specialist comments. "Those accounts which did manage to get their hands on borrow will certainly be able to extract value, but it's only there in dribs and drabs."

In terms of distribution, observers say that about 120 accounts participated in the Reg S deal, with a geographical split that saw 50% placed in Europe, 25% in Asia and 25% offshore. The majority of buyers were said to be outright accounts.

Outside observers describe terms are fair to cheap given the issue size, with a number pointing out that the conversion premium is very low relative to other recent Hong Kong issuers. However, supporters say that the company wanted to ensure conversion and as a result, the deal also incorporates a very low call hurdle. On full conversion, the dilution will amount to about 6%.

The company is likely to have chosen a convertible because it ultimately wants to reduce gearing and the straight equity markets remain fragile, reducing the appeal of a block trade. Hang Lung would, therefore, not have been keen to follow Hysan's lead with a straight bond offering and since it only recently completed a syndicated loan, this would have been ruled out as an option as well.

Launched in January, a HK$3 billion loan with a split five and seven-year maturity, paid a blended all-in yield of 55.9bp over Hibor. Lead arrangers were BayerLB, Hang Seng Bank, HSBC and Standard Chartered.

The sudden financing spree has been prompted by the company's transformation from property investor to property developer and its desire to lock in funding at the bottom of the interest rate cycle. Unlike most Hong Kong property companies, which average gearing ratios of about 20%, Hang Lung currently stands at 25%.

Nomura analyst Gary Chan estimates that gearing will peak in 2003 at 38% before starting to drop off again in 2004. The increase is the result of a HK$13 billion capital expenditure programme to complete four major property developments, including two in West Kowloon and the one million square foot development of Kowloon Station.

But Chan also says that the company's strong recurrent income from its large property portfolio makes Hang Lung a very balanced play, with stable coverage ratios. Most analysts tend to rank Hang Lung at the bottom of Hong Kong's tier 1 property companies and calculate that it is presently trading at its historical average of a 30% discount to NAV (HK$10 to HK$12).

About 92% of the company's asset value comes from Hong Kong property and the remaining 8% from the Mainland's property sector. As of Year-end June 2001, the company had a net debt position of HK$6.6 billion, with analysts expecting the figure to rise of HK$8.9 billion by June 2002.

Given that most Asian convertibles are Taiwanese tech related deals, Hysan's new issue adds welcome diversification. In previous years, Hong Kong property companies formed the bulk of equity-linked issuance from the Territory but have been noticeably absent in recent years. They are also likely to stay that way, as most are well capitalized and rely on internal funding or the loan markets to fund their more limited development activities.

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