Hynix surprises market with high coupon CB

The 4.5% coupon allows the memory-chip maker to achieve a premium above 40%, but the strong demand suggests investors think it is good value.
Korean memory-chip maker Hynix Semiconductor has secured $583.4 million from a convertible bond that raised a few eyebrows because of its high annual coupon.

The bond, which was launched and completed after the market closed yesterday, is also noteworthy because of the inclusion of no less than six joint bookrunners, of which only Credit Suisse and Woori Investment & Securities were retained from the companyÆs previous CB issue last year. This time they were joined by Goldman Sachs, Korea Development Bank, Macquarie Securities and Morgan Stanley.

Having gone out with a range of 4.5% to 5%, the final annual interest payment was fixed at 4.5% which was higher than on any other convertible from Asia ex-Japan in recent years. In fact, the bonds looked more like the cash paying CBs that come out of Australia than your typical Asian CB, which tends to have a zero coupon. The premium was fixed at the top of the indicated range of 32% to 42%.

Sources say this structure was chosen in order for Hynix to achieve its double objective of a high initial conversion premium and a low yield, while at the same time increasing the likelihood of conversion. The company issued a zero coupon CB with a 30% conversion premium in September last year, which because of a slide in the share price, is currently trading deeply out of the money with an effective premium of about 76%. This makes it highly likely that the bond will be put back to the issuer at the next anniversary and has made Hynix keenly aware that not all CBs do convert.

The par in/par out structure also makes sense in light of the current volatile credit markets and the fact that the deal is coming at a time of year when investors arenÆt that keen to take on new exposure, the sources argue. On top of that, the company warned potential investors in the CB term sheet that it was likely to post a loss both at the operating and net levels in the fourth quarter due to falling selling prices for memory chips.

ôIf you donÆt want to compromise on the conversion premium, this structure is the right one,ö says a source.

That may be, but observers still argued that the high cash payments made the bond look cheap and noted that this structure could have been applied to the same effect with a lower coupon.

Whether they are right or not, it was quite clear that investors didnÆt consider the bond expensive. Not only did the CB trade up to about 101.50 in the grey market shortly after launch, but the deal ended up more than 10 times covered in the one-and-a-half hours that the books were open. About 200 investors participated, displaying none of the end-of-year hesitancy that bankers have been talking about for the past couple of weeks.

One reason for the high order inflow would have been the fact that the deal was well flagged, meaning investors were well-prepared and had had plenty of time to work out what they would be willing to pay for a chance to participate in HynixÆ potential equity upside.

Investors would also have been attracted by the fact that you can short the equity, meaning it is possible to trade the volatility. However, there are some limitations here as the number of shares available for borrowing is by no means large enough to match the deal size.

A reference point for this bond would have been Pacific BasinÆs $350 million CB last week, which was generally regarded as cheap. That bond had a five-year/three-year put maturity and a 3.3% coupon, but a lower conversion premium of 27%. People close to the Hynix bond say the Hong Kong-based shipping company is also a stronger credit and have more shares available for borrowing.

The Hynix deal also has a five-year maturity, but the put will kick in at 2.5-years, which seems a bit odd in combination with the companyÆs desire to see the bonds convert into equity. The issuer has the option to call the bonds after three years, subject to a hurdle of 130%.

The deal was launched with a fixed amount of underlying shares, which meant that the pricing at the tight end of the terms led to larger deal size than the $500 million indicated on the initial term sheet. At $583.4 million, this is the second largest equity-linked deal out of Korea this year after KCCÆs $1 billion exchangeable that was split into three tranches.

The bookrunners offered no credit bid, but relied on the fact that Hynix is a fairly familiar and well-understood credit with rating of BB- from Standard & PoorÆs and Ba2 from MoodyÆs. Aside from last yearÆs CB, the company also issued a high-yield bond earlier this year. That bond pays a coupon of 7.875%, which suggests that the company may have considered the 4.5% it will have to pay on the CB quite bearable.

There are also outstanding credit default swaps in HynixÆs name and based on a combination these, the guidance was that the credit was worth about 450 basis points over Libor and investors were said to have had no issue with that. Other assumptions included a 3% stock borrow cost and a full divided pass-through.

This gave a bond floor of about 91% and an implied volatility of 31%. The latter can be expected to move a bit higher given the likelihood that there may be some stock slippage when trading opens today. The share price has been under significant pressure since mid-August, losing as much 43% of its value at one point. Since late November it has staged a mini-recovery, however, and has moved up from a low of W22,500 to yesterdayÆs close of W27,000. Based on that close and the 42% conversion premium, the initial conversion price will be W38,340, which is below the July high of W39,200. It is also only just above the W36,200 level where it traded when the previous CB was issued in September last year.

YesterdayÆs profit warning is likely to put some additional pressure on the stock, but may be somewhat offset by a favourable research report on the memory chip sector by Citi earlier in the day. The US investment bank argued that the memory chip cycle will hit the bottom earlier than expected in the first quarter 2008 and said it expects a sector recovery within the first half of next year. On the back of this call, it upgraded Samsung Electronics to a æbuyö and Hynix to ôhold.ö It also raised its target price for Hynix to W31,300 from W23,500, implying 16% upside in the coming 12 months.

According to the brief information provided in the term sheet to back up HynixÆ profit warning, 512MB DRAM prices fell 34% between the end of September and December 6 and 8GB MLC Nand flash memory prices dropped 37%. As a result, the company said, the average selling prices of its main products ôhave fallen more rapidly than anticipated.ö

The company reported an operating profit of W254 billion ($277 million) in the third quarter.

The company reported an operating profit of W254 billion ($277 million) in the third quarter. The proceeds from the CB will be used for general corporate purposes, including capital expenditures needed to expand its 12-inch semiconductor capacity.
¬ Haymarket Media Limited. All rights reserved.
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