Hutchison returning to international bond markets

The group mandates three banks for $1 billion equivalent financing.

In a bid to term out its maturity profile and ease pressure on its capital structure, Hutchison Whampoa is set to re-finance bank loans relating to its recent acquisition of Dutch retail company Kruidvat with a $1 billion equivalent bond issue.

Unusually the diversified conglomerate has awarded books to three of its biggest 3G lenders rather than a host of US investment banks. Where previously Goldman Sachs and Merrill Lynch have dominated its capital markets business, Deutsche Bank, HSBC and JPMorgan will lead manage a deal this time round.

All three have, however, worked for group before. JPMorgan acted as one of three bookrunners on Hutch's $1.5 billion 10-year bond issue of February 2001, while Deutsche and HSBC led Asia's inaugural euro-denominated bond in March 1999, when Hutchison raised Eu500 million deal via a seven-year deal priced on a coupon of 5.5% to yield 170bp over Bunds.

Observers say that Hutchison has gone to extraordinary lengths to keep the new bond deal quiet and, therefore, although launch is said to be imminent, few details are yet know.

Indeed, while some speculate that Hutchison will launch a multi-currency issue, others believe that a jumbo euro-denominated transaction is in the offing. This is based on the fact that the Kruidvat acquisition was paid for and then part financed in euros. Hutchison group finance director Frank Sixt has also recently been extolling the virtues of the currency, arguing that general market conditions have become favourable, liquidity is increasing and Hutchison should take advantage of any opportunities to distinguish itself from Europe's many heavily indebted telcos.

As news of a potential transaction began to leak out into the market yesterday, secondary market spreads started to widen, with the group's benchmark 2007 and 2011 bonds respectively widening by 5bp and 8bp. At Asia's close, the 6.95% August 2007 issue was trading at 108.09% to yield 5.05% or 195bp over Treasuries, while the February 2011 was trading at 103.34% to yield 6.48% or 243bp over Treasuries.

At these levels, many analysts believe the market has factored in a one to two notch downgrade of the company's current A/A3 rating. And according to Barclays Capital research, the Hutchison 2017 bond is Asia's cheapest in terms of spread to Treasury relative to rating.

When the company last came to the dollar market in February 2001, it paid a roughly 40bp premium to the MTR Corp curve on a like-for-like basis compared to a historical premium of 10bp to 15bp. Yesterday, Hutch was trading at a 163bp pick-up to MTR Corp's November 2010 bond, which is only four months shorter than Hutch's March 2011 bond.

It was also trading at a 72bp premium to Hong Kong Land, which has a one notch lower rating from Standard & Poor's, a 14bp premium to Jardine Strategic which has a one notch lower rating from both agencies and remarkably, a 30bp premium to Wharf, which has a Baa3/BBB rating.

The decision to re-finance an Eu1 billion committed loan facility has surprised some market participants, since the five-year bullet deal is tax efficient and covers 65% of the Eu1.3 billion acquisition cost of Kruidvat. The loan is believed to have been priced at 150bp over euribor, a high level relative to the kinds of Libor based spreads most Hong Kong corporates can achieve.

But the rationale for the bond deal is likely to lie in the cost efficiency of the price Hutchison thinks will be required in order to achieve a maturity extension. The company has a heavy debt maturity schedule over the next four years, with 66% of its $20.04 billion gross debt falling due.

It is also well aware that it stands on the brink of a ratings downgrade, with both agencies placing it negative outlook and Standard & Poor's recently hinting that a downgrade is likely unless the company actively does something to improve its credit ratios. The US agency has been particularly unimpressed with the Kruidvat acquisition, releasing a statement that the purchase would impact the company's credit profile.

In an investor conference call sponsored by HSBC last month, Hutchison officials said the acquisition was intended to diversify the Watsons brand away from Asia and expect 75% of Hutchison's retail revenues to derive from Europe and only 25% from Asia going forwards. The company said that Kruidvat's 1,900 shops in Holland and the UK will be used to sell the company's new 3G phones, at the same time emphasizing that this was not the main reason for the purchase.

In the same call, company officials stated that while net debt to capitalisation had officially increased from 1% to 12.2% at the end of the first half, net gearing was really only about 7.5% because of a turnaround in the share prices of the company's Vodafone and Deutsche Telekom holdings during August.

"Hutchison does not expect gearing to go into the high teens in the near term, thereby offsetting investor concerns about is rising gearing trend," HSBC wrote in an accompanying research piece published on August 23.

Analysts have also pointed out that the EBITDA generated by the Kruidvat stores will also boost Hutchison's coverage ratios, with EBITDA net interest coverage standing at 5.8 times as of end 2001. However, analysts also believe that gross debt to capitalisation will increase by 2.5% to 41% as a result of the associated financing. In 1999, by contrast, Hutchison reported a 26% ratio on gross debt of $11.56 billion.

Both the Eu1 billion loan and subsequent bond issue also reflect Hutchison's desire to uphold its large cash pile. As UBS Warburg analyst Tse-Ern Chia wrote in a recent research report, "In view of rising business risks and increasing debt trend, we believe that Hutch would be keen to maintain a deep liquidity cushion to protect its financial flexibility."

These business risks are entirely telecoms related, with analysts highlighting two worrying issues relating to its 3G business, which the company is scheduled to start rolling out in the UK next month. The first concerns its equity investments in Vodafone and Deutsche Telekom. While Hutch marked the securities to market in June 2002 (down $1.42 billion), it did not make any provisions for them in its P&L, because it said it had no intention of selling the stakes at current market levels.

The second relates to the carrying cost of its 3G businesses, for which it has set aside $16.7 billion for licenses and capex investment. KPN, its partner in Hutch 3G UK recently wrote down the value of its 15% stake to GBP150 million, assigning an overall valuation of GBP1 billion to the venture. By contrast, Hutchison, which has a far more optimistic view of its 3G prospects, still maintains its original valuation of GBP2.6 billion for a 65% stake.

On the plus side, the company's cash pile is very large ($15.61 billion end June), its 3G businesses are fully funded and EBITDA continues to be well supported by its diversified operations in the ports, retail, infrastructure, property and energy sectors.

From Hutchison's perspective, a bond deal now makes sense in the context of a low interest rate environment and ahead of potential headline risk concerning slower than expected take-up after the new 3G service commences in October. The company has always shown itself to be one of Asia's most savvy borrowers when it comes to timing its transactions and it will interesting to see how it is able to position itself after losing its customary upper hand with investors.

From an investment standpoint, observers believe the new deal will help fill a shortage of investable assets and play well in Asia where Hong Kong based investors are still flush with liquidity and less sensitive to 3G related concerns.