Two Japanese companies issued mammoth convertible bond deals on Tuesday, returning to the market after long absences and raising a combined ¥300 billion ($2.6 billion) amid a week of substantial change and likely volatility in the global credit market.
Mitsubishi Chemical, Japan’s largest chemical manufacturer, was first out of the blocks to launch a dual-tranche convertible totalling $1.3 billion after market close. Kyushu Electric Power immediately followed with another dual-tranche convertible of identical size.
The two bonds were rare supplies of new paper amid sluggish deal flow since the beginning of the year. What caught market attention was also the magnitude of the deals, which were gigantic even by the standards of Japan, where abundant liquidity means larger deals are more common than elsewhere in the region.
According to Dealogic, the two transactions alone were equivalent to more than half the $4.6 billion raised from all convertible bond issuance out of Japan last year. In US dollar terms, they are the joint second-biggest convertible deals in Asia since November 2012, when Sony isued a $1.9 billion five-year bond.
More importantly, the two issuers seized perhaps the last window to execute a trade before the Bank of Japan’s two-day monetary policy meeting on Wednesday and Thursday. The central bank will decide whether to slow its monetary easing strategy, or even bring its benchmark lending rate out of negative territory.
The BoJ has kept the country’s interest rate at minus 0.1% since January last year.
Even if the BoJ leaves its rate unchanged, Japanese companies are set to face relatively higher funding costs after a near-certain US rate hike later this week, which would make rival income-generating products in the US more attractive.
Mitsubishi Chemical
Mitsubishi Chemical returned to the convertible market after a ten-year hiatus, issuing ¥150 billion worth of zero-coupon bonds, equally split between a five-year and a seven year tranche.
The five-year tranche was marketed at a premium range of 40% to 50% over the ¥899 reference price, before settling at 41.94% and a conversion price of ¥1,276. For the seven-year tranche, the conversion price was fixed at ¥1,258, equating to a conversion premium of 39.94% over the 35% to 45% marketed range.
One source familiar with the situation said it was the longer-tenor bond that got more demand, since it allows bondholders to lock-in two extra years of investment at almost the same level of conversion premium.
Asset swaps were available for about one-third of the total deal size – at 60bp over Libor for the five year and 70bp over Libor for the seven-year tranche, according to the source. That tight difference between the swap rates means the two tranches had an almost identical implied volatility of 26.5% at their respective final prices.
Based on the credit assumptions, the five-year tranche has a bond floor of 96.4% while that of the seven-year note is lower at 92.9%.
Convertible bond analysts were modelling the new deal with a low stock slippage because it was launched at the same time as a buyback of secondary shares. The structure, known as a recap convertible bond, facilities the bond issue because the stock repurchase helps mitigate potential share dilution.
Mitsubishi Chemical said it would repurchase ¥30 billion of stock and had bought back ¥22 billion as of Wednesday morning. As a result, shares were down only 3.2% at midday on Wednesday despite the huge scale of the bond sale, which was equivalent to 11.3% of the company’s market value.
Kyushu Electric
By comparison, Kyushu Electric Power shares dropped by a larger margin of 8% midday Wednesday after its sale of a ¥75 billion three-year bond and another five-year note of the same size, marking a return to the asset class since selling its last convertible bond in 2002.
The power supplier at the southern Japanese island sold the three-year tranche at a 15% conversion premium over the reference price, which was towards the lower end of the 12% to 24% marketed range. The final conversion price was fixed at ¥1,434.
The five-year tranche, which was guided at the same premium range, was sold at a 17.96% premium that translated to a strike price of ¥1,471.
Comparing the two issues, Mitsubishi Chemical was able to achieve a higher premium despite its weaker credit profile. The chemical company is rated A+ by Japan Credit Rating Agency, one notch lower than Kyushu Electric’s AA-.
Sources said Kyushu Electric had to resort to a lower premium partly because the stock had less potential upside as a utility company, while its leverage is also much higher.
In addition, shareholders of Kyushu Electric are facing higher operational risks; the company operates the Sendai nuclear power plant, which was forced to close following the deadly Fukushima incident in 2011. Regulators allowed it to reopen in 2015.
Active joint bookrunners of Mitsubishi Chemical’s bond sale were JP Morgan and Morgan Stanley. Goldman Sachs was a passive bookrunner.
Nomura and Mizuho were joint bookunnrers of Kyushu Electric’s deal.
