Hony Capital trims stake in CSPC Pharmaceutical by $154 million

The upsized deal comes at a 10.2% discount and will open the door for the private equity firm to convert part of an $860 million CB following a surge in the share price.

A company controlled by Chinese private equity firm Hony Capital last night sold part of its stake in Hong Kong-listed CSPC Pharmaceutical, raising HK$1.2 billion ($154 million).

While it didn’t spell it out directly, the sale is likely to have been prompted by a desire to convert some of its CSPC Pharma convertible bonds after the share price has rallied 80% this year. According to the conditions, the CB can only be converted into shares if the free-float remains above the required 25% and since the free-float is currently 25.2% Hony needed to reduce its existing holdings first.

The vendor offered to sell a 10.2% stake in the form of 277.3 million shares, but said it may increase that by another 55.5 million shares in case of demand. As the demand was very strong, the 20% upsize option was exercised in full, lifting the total deal size to 332.8 million shares and 12.2% of the company.

It also reduced the stake of CSPC Pharma’s controlling shareholder to about 62.4% from 74.6% and boosted the free-float to around 37.4%. Hony owns about 75% of the parent company while the management holds the remaining 25%. In turn, Hony is 34.5% owned by Legend Holding, a Chinese investment company that is also the controlling shareholder behind computer manufacturer Lenovo.

The shares were offered at a price between HK$3.50 and HK$3.80 each, which translated into a discount of 5.2% to 12.7% versus yesterday’s close of HK$4.01. The discount was definitely wide at the bottom of the range, but in light of the sharp share price gains year-to-date it did seem fairly reasonable. The stock is also quite volatile and not that liquid — the final deal size accounted for about 25 days of trading.

Sources said the bookrunners had pre-launch order indications to cover the entire deal, including the upsize option. The fact that they still chose to launch with a smaller size suggests that the issuer was keen to push the price a bit.

After close to three hours of bookbuilding the price was fixed slightly below the mid-point at HK$3.60 for a 10.2% discount, while the upsize option was exercised in full.

The deal was multiple times covered at the final size and price with orders from close to 80 investors, the sources said. The buyers included existing shareholders, China funds and a couple of dedicated healthcare funds as well as more general long-only investors and hedge funds.

There was also said to have been a fair bit of participation from the US.

The controlling shareholder owns its combined stake through four different entities. The selling entity, Jinling Investment, will hold about 16.9% of the company after this transaction, which will be locked up for 90 days.

Having initially been a manufacturer of bulk drugs — mainly penicillin and vitamin C — CSPC Pharma last year transformed itself into a producer of innovative and branded drugs through the acquisition of three businesses from its parent company. The purchase gave it a more diversified product range and, according to the company’s 2012 annual report, it established a new business model of high growth and high profit, while at the same time being less volatile.

Mainly as a result of the acquisition, CSPC Pharma’s revenues increased by 72% to HK$4.15 billion in 2012, while the net profit grew by 508% to HK$2.16 billion.

The company paid HK$8.98 billion for the new businesses, of which HK$2.27 billion was paid through the issuance of new shares to the vendor and HK$6.7 billion ($860 million) through a US dollar-denominated CB. The latter has a five-year maturity and pays no coupon. The conversion price is HK$2.15, which represented a 4.9% premium to the last closing price of HK$2.05 and a 40.5% premium to the average closing price in the previous 30 days when the acquisition was first announced in June last year.

However, at the moment the conversion price is at a 46.4% discount to the current share price, making it a tempting proposition to convert the bonds into shares. Aside from the limits imposed by the free-float restrictions, the holder has been free to convert $774 million worth of CBs (tranche 1) since March 31. The remaining $86 million worth of CBs (tranche 2) can be converted starting from the same time next year.

CSPC Pharma’s share price closed at a record high of HK$4.28 on April 18, but has come back slightly since then. Yesterday it fell 3.4% despite a 1% gain in the benchmark Hang Seng Index.

As mentioned, the stock is quite volatile and that kind of drop (or gain) in a single session isn’t unusual. That said, there seems to have been some talk in the market about the pending deal, which may have had an effect. The three bookrunners had been wall-crossing investors for the past couple of days and at 5pm Hong Kong time yesterday — two hours before the deal launched — a story appeared on Bloomberg saying that Hony was considering selling a $300 million stake in CSPC Pharma.

Since the market was closed at the time, the report itself wouldn’t have prompted investors to position themselves for the trade, but it is possible that the same information had circulated to other players earlier in the afternoon. If so, the fact that the deal turned out to be only half the reported size, may have led to a bit of a demand squeeze.

Sources said the bookrunners had been sounding out the market for a slightly larger deal, although it was unclear where the $300 million number came from.

The deal was led by Bank of America Merrill Lynch, Morgan Stanley and UBS.

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