Hopson brings renminbi-denominated CB to foreign investors

The deal marks the sixth placement of Hopson stock in the past 12 months - all of which have been arranged by Credit Suisse.
Hopson Development was in the market again yesterday selling the equivalent of $225 million worth of renminbi-denominated but US-dollar-settled convertible bonds in another move to finance existing and new projects as well as potential acquisitions of new land.

This was the second fundraising by Mainland-based Hopson in two-and-a-half months after it did a placement of HK$996 million ($128 million) in new shares in early November. Credit Suisse acted as sole bookrunner for that placement as well as yesterdayÆs CB. The investment bank has done very well out of its relationship with Hopson in the past 12 months as it has also arranged the divestment of the original private equity stakes held by Temasek and the Tiger Fund through four separate placements.

The three-year, zero-coupon bond issue marks the first time a company has issued CBs in renminbi that are then settled in another currency. The decision to do so, according to people familiar with the transaction, is related to a stricter interpretation of new accounting rules which have the potential of making a companyÆs earnings more volatile.

The rules require the options element of a CB to be treated as a derivative that has to be marked to market and accounted for through the profit and loss account û if the convertible is denominated in a currency other than the companyÆs operating currency. The difference in accounting treatments only applies as long as the bonds havenÆt been converted to equity.

Mainland-based HopsonÆs operating currency is the renminbi, which means these new rules would kick in if it was to issue CBs in any other currency, including dollars. And since the renminbi isnÆt fully convertible the company needed to make sure the bonds were settled in another currency to enable foreign investors to buy it.

ôThis will set a precedent for other Mainland issuers to follow,ö says a market source familiar with the deal, noting that this rule could become a real issue for Chinese companies that want to raise funds through CBs in the international capital markets depending on whether all the major audit firms start to implement the same strict treatment.

For investors, the structure brings added risks since the underlying currency can move against them between launch and redemption or conversion. However, there are few economists who believe the renminbi will move in any other direction than up against the US dollar over the next few years, making this more of a positive story in that it provides exposure to the future upside of the Chinese currency.

Indeed, with the Hopson bond there were no signs that investors felt they needed to get compensated in any way for this additional risk.

The company sold Rmb1.83 billion ($225 million) worth of bonds, including a 12.5% greenshoe that was exercised straight away. The offering met with massive demand even though the sale came on a day when the stock bounced 10.3% to within 25 HK cents of its record closing high from last month.

Investors were told they couldnÆt submit orders for more than $30 million, but even so, the deal was covered one hour after the launch at 2.30pm Hong Kong time. When the books closed at 5.30pm it had attracted $1.3 billion worth of demand from more than 90 investors, one source said. Given the timing of the sale, participation by offshore US investors was limited, but European investors were said to have accounted for a significant portion of the demand.

Despite the strong interest, however, the pricing wasnÆt pushed to the very tight end. The yield was even fixed above the mid-point of the indicated 1.125%-1.625% range at 1.5%. However, the conversion premium was also set in the upper half of the 33%-38% range at 36.73%, which from the companyÆs point of view would have compensated somewhat for the higher yield.

Based on yesterdayÆs closing price of HK$22, this premium gives a conversion price of HK$30.08. The issuer has the right to call, or buy back, the bonds after the first year, subject to a 120% hurdle.

The assumptions included a credit spread of 190 basis points over the dollar-renminbi non-deliverable forward interest rate curve. Credit Suisse offered a small amount of non-call credit default swaps at this level, but given that the company has an outstanding 2011 high-yield bond that acted as a visible benchmark, not too much of that was said to have been taken up.

The bondholders will be compensated if the dividend payout ratio goes above 40%, which equals a yield of about 2.5% based on current prices, and the stock borrow cost was assumed at 5%. This gave a bond floor of 94.6% and an implied volatility of 33.5%. The latter may seem high, but is in fact well below the 250-day historic volatility of 53.5%.

The source noted that the high volatility in the stock, which has resulted in many ups and downs even as the share price seen has risen 82% in the past 12 months, means the 1.8 point value of the equity option every year cannot be considered expensive.

ôThis stock whips around a lot and if it whips in the right direction, investors will be laughing,ö he says.

This week has given a taste of that volatility with the stock gaining 8.3% on Monday and 2.4% on Tuesday before dropping 6.8% on Wednesday after the Chinese government said it will start to collect a land appreciation tax that it introduced already in 1993 but which has so far only been enforced in a few geographical regions. Other developers also fell on the announcement with Guangzhou R&F Properties and Agile Properties both shedding between 8% and 9%, Greentown China down 7.1% and Shimao Properties off 5.1%.

After analysts pointed out that most property companies are already booking this tax as a cost on their P&Ls and said the tax would have a muted impact on the earnings of most developers, the sector bounced back on Thursday. By lunchtime, Hopson had added 10.3% after which it was suspended from trading to carry out the CB transaction.

In a report issued in connection with the land tax news under the title ôMuch Ado About Littleö, Merrill Lynch named Hopson its top pick in the sector with a target price of HK$34.

With regard to the new accounting rule, one banker noted that it was in place throughout last year, but only became an issue during the autumn when PriceWaterhouseCoopers started to push some of the companies that it audits to also treat CBs under the new regulations.

In a statement issued in late September, Singapore-listed China Sun Bio-chem said it would have to adjust its nine-month earnings with regard to two outstanding dollar-denominated CBs to take account of the new rules. PwC is the auditor for both China Sun and Hopson.
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