The launch of the 2.2 year transaction after New York's close on Tuesday has taken the market completely by surprise and must rank as one of the quietest launches of an equity deal from Asia in over a year. In essence, the 144a deal results from a re-organisation at Hyundai Motor and its disaffiliation from the founding Chung family. Following a subsequent share buy-back scheme at Kia, the company's holding in its affiliate (purchased in March 1999), has risen to 53% and will now be pared back by 13.1%.
The triple-A rated deal mirrors an earlier groundbreaking exchangeable by the Industrial Bank of Korea (IBK) into Korea Tobacco & Ginseng (KT&G) in December last year. Credit Suisse First Boston is the bank responsible for the unusual structure of both deals, which essentially offer issuers a clever monetization tool for complicated divestments that might otherwise take years to come to market because of liquidity, documentation, or credit issues.
However, because of the level of overcollateralization needed to achieve a triple-A rating, issuers receive no upfront proceeds and some bankers have consequently questioned the structure's usefulness. "From a corporate finance perspective it makes very little sense to me," says one. "Proceeds from an offering are invested in the collateral to back the deal, so the issuer only ends up receiving about 5% to 10% net cash."
For an issuer needing to raise working capital, the structure is, therefore, of little use. But for an issuer that has no immediate use of proceeds, yet remains keen to dispose of an unwanted equity stake, the structure has a number of benefits. For Hyundai Motor, which has been attempting to reduce gearing since the middle of 1999, this kind of structure means that it incurs no additional debt on its balance sheet.
Because the company carries a weak Ba3/BB- rating, an uncollateralized exchangeable structure would also prove more costly for the company in the current market environment and tough to market among a risk-averse investor base. A credit enhanced structure, on the other hand, should be more cost efficient for the issuer and an easier sell to investors that have to give very little thought to credit.
According to US investors, terms for the deal comprise a coupon of 1.75% to 3% and a conversion premium of 15% to 23%. The deal also has a par in, par out structure. It is not believed to have won on a bought deal basis and there will be no further syndicate, nor a greenshoe.
At the top end of the indicative range, investors say that the deal has a bond floor just under 96% and fair value of 109% to 110%. Implied volatility stands at about 30% and there is no dividend yield.
The nearest pricing benchmark is the $352.9 million IBK exchangeable from December, which carries a premium redemption structure. With a 1.5% coupon and 18% conversion price, the 2.6 year deal had a launch yield-to-maturity of 4.14%, equating to 120bp through Treasuries. There was bond floor of 94.7%, fair value of 105% and premium redemption at 107.35%. The deal is currently quoted at 101%/101.5%.
Proceeds from Hyundai Motor's issue will also be invested in US Treasury Strips, which serve as the collateral for the triple-A rating. Similar to the IBK deal, investors say that it has been structured on a one-for-one basis, such that for every $1 of coupon liability, there will be a $1 treasury strip redemption.
The pure credit pass-through structure on which the deal hinges is structured around two SPV's (special purpose vehicles), which create bankruptcy remote vehicles removing Hyundai Motor's individual credit standing from the picture.
The first SPV (Cayman Islands) issues an exchangeable to investors and invests the proceeds in US Treasury strips to meet all coupon and principal obligations on the notes. Additional proceeds are used by Hyundai Motor to obtain option premiums from the Cayman's SPV via the Korean SPV. In return for these option premiums, Hyundai Motor entrusts the Korean trust with 51 million Kia Motor shares, representing a 13.1% stake.
The Korean trust then issues a senior certificate (call option) back to the Cayman SPV and a junior certificate to Hyundai Motor. The call option allows noteholders to exchange their pro rata share of collateral for the relevant number of Kia Motor shares held by the Korean trust. As junior certificate holder, Hyundai Motor then receives cash, shares or a combination of the two depending on the ultimate level of conversion when the bond matures in 2003.
Similar to IBK, a short maturity is likely to have been chosen because investors are largely indifferent to duration with triple-A paper. The lead would also have needed to find a liquid series of Treasury strips. Unlike IBK, which has a high dividend yield of 7%, Kia Motor is a growth stock paying virtually no dividend.
One of the chief attractions of the offering is likely to be the combination of a high and precise (US government) bond floor and a extremely volatile stock, albeit one that is difficult short. The shares underlying the exchangeable are believed to represent about 30 to 35 trading days.
Year-to-date, Kia Motor has risen 52.11%, closing Tuesday in Korea at W10,800. Hyundai Motor has performed even more strongly, up 110.83% and closing Tuesday at W24,300. Both have vastly outperformed the Kospi index, up 25.253% on the year.
Between them Hyundai Motor and Kia Motor control roughly 73% of the domestic auto market. Since the beginning of the year, both stocks have been pushed by strong earnings momentum, recently underlined in first quarter results. Hyundai saw unconsolidated net income rise from W215.7 billion (166.56 million) to W275.9 billion ($213 million). Kia, meanwhile, recorded 18% growth in sales from W2.42 trillion in March 2000 to W2.86 trillion in March 2001.
The company has attributed both companies strong performance to three factors: disaffiliation from the Hyundai group; a strategic alliance with DaimlerChrysler and a change in its sales mix following the introduction of more recreational vehicles such as the highly popular Santa Fe sports utility vehicle (SUV).
Disaffiliation from the controlling Chung family was completed in September 2000 with: the sale of all remaining stakes in Hyundai-affiliates; the abolition of dual directorships and the reduction of Chung Ju Yung's stake from 9.10% to 2.96%. The company then set about improving corporate governance and shareholder value. Its board of directors, for example, has been reduced to eight, of whom four come from outside the company, including one on secondment from DaimlerChrysler.
The DaimlerChrysler alliance was cemented in June 2000 and the company has said that it hopes the partnership will help improve competitiveness and more importantly, allow it to become a truly global player. At the moment about 46% of sales are domestic and 54% overseas.
DaimlerChrysler's 10% equity participation also gave the company a cash boost, which has further aided its capital restructuring and debt reduction plan. The first stage was a domestic rights offering in May 1999, followed by a $500 million GDR (also led by CSFB) and domestic rights offering towards the end of the same year. As a result, debt to EBITDA (unconsolidated basis) dropped from 6.36 times in 1998 to 3.45 times in 1999, while interest coverage ratios improved from 1.49 times to 2.51 times.
Yet as Asian fund management firm Income Partners wrote in a recent report, "Hyundai Motor's debt maturity profile is heavily skewed to the short end, with approximately W3.3 trillion ($2.6 billion) of debt maturing in the next two years (as of June 2000). This represents 82% of total debt and could potentially pose refinancing risks."
However it added that in Hyundai Motor's case, "We currently see such risks as immaterial. This is due to the company's comfortable leverage (Debt/EBITDA = 2.8 times) and interest coverage (EBITDA/interest = 3.89 times) positions."
Pricing will take place by midday on Thursday (GMT).