In fact, this was the largest equity-linked transaction in Korea so far this year, falling just below the $1.03 billion equivalent deal for Korea Electric Power Corp (Kepco) in November 2006 that was split into two tranches denominated in euros and yen.
The execution of yesterdayÆs deal too was made slightly easier by the fact that it is exchangeable into three different underlying stocks û treasury shares in KCC itself, ship builder Hyundai Heavy Industries (HHI) and marine transportation company Hyundai Merchant Marine (HMM). And by indicating that there would be no disproportionate allocation into the most attractive of the three tranches, which was HHI, the bookrunner was able to push the yield away from the most generous end on the other two tranches as well.
The pricing was also helped by the fact that there havenÆt been that many convertibles or exchangeables by Korean issuers since the Kepco offering. That scarcity effect was further compounded since KCC is a triple-B rated credit and Asia as a whole has seen no more than a handful of equity-linked issues of investment grade quality this year.
There was no information on the final size of the book, although sources say it was multiple times covered when it closed after about 4.5 hours of bookbuilding. A couple of the more than 60 investors that participated in the offering essentially confirmed this by noting that allocations had been quite low in proportion to the order sizes. All three tranches were also priced at par and traded up to between par and 101% in the aftermarket post pricing.
The tranches have the same five-year maturity with a three-year put and a zero coupon and are exchangeable into the underlying stock after the first anniversary. There is an issuer call after three years subject to a hurdle of 130%.
The full $1 billion was split into a $278 million tranche A that is exchangeable into KCC treasury shares, a $272 million tranche B exchangeable into HHI shares and a $450 million tranche C that can be exchanged into HMM shares. Tranche C was considered the least attractive, partly because of the chunkier size, partly because HMM is a much smaller company than the other two and a lot less liquid û despite being the countryÆs second largest shipping company and a core component of the Hyundai Group before that was split into several business units in 2000.
HHI, on the other hand, is a highly liquid stock with about $120 million worth of trades every day and a market cap of $33 billion. The stock is also easy to borrow, which means investors are able to hedge the equity option and thus could buy the bonds as a pure volatility trade. Or as one observer puts it: ôHHI is a real company and tranche B is definitely the most interesting of the three.ö
ôHMM and KCC are more vanilla outright trades with modest premiums, but they are backed by a very good credit so they too are a good trade,ö adds another source.
The greater popularity of tranche B was obviously well anticipated as it was offered at a much higher premium of 45% to 55%, compared with a 20% to 30% range for tranches A and C. This didnÆt deter investors, however, and the premium on tranche B ended up being fixed close to the top end at 53%, while the yield to put was set at 2.6% after being offered in a range between 2.05% and 2.8%. The premiums were set with reference to yesterdayÆs volume-weighted average price for each of the stocks, which for HHI translated into W435,187. At 53%, this is the highest premium for a Korean equity-linked deal ever, exceeding the 52% achieved on a bond issued by Posco in August 2003 that was exchangeable into SK Telecom shares.
Tranche A (into KCC shares) was priced with a 23% premium over the VWAP of W575,090 and a yield of 1.45%. The yield was initially offered in a range of 1.2% to 1.95%.
Tranche C had a slightly wider yield range of 1.4% to 2.15% to account for the larger size, but here too, JPMorgan was able to push it inside the wide end to 1.9%. However, the premium was fixed at the bottom of the range at 20% over yesterdayÆs VWAP of W43,721.
The pricing was based on a credit spread of 80bp over US Libor, and thanks to the triple-B rating the bookrunner didnÆt have to provide any asset swaps or credit default swaps to convince investors to take the bonds on board. This proved to be true even though KCC CDSs were quoted as high as 115bp over Libor after the deal.
For tranche B, the stock borrow cost was assumed at 1.75%, which was higher than what was suggested by other market participants last night, but sources say this was to take account of the high transaction costs in Korea. However, some investors were said to have been able to use 1.5%, while theoretic assumptions went as low as 0.5%. The stock borrow cost for tranches A and C was assumed at 5%.
Investors holding the bonds exchangeable into KCC and HHI will be protected for a dividend yield above 2%, while holders of the bonds exchangeable into HMM will be compensated if the dividend yield exceeds 1%.
Based on these assumptions, tranche A was priced with a bond floor of about 89% and an implied volatility of 32.5%; tranche B with a bond floor just above 92% and an implied volatility of 37.5%; and tranche C with a bond floor just over 90% and an implied volatility of 30%. Given that the other two has limited or no borrowing, the volatility on tranche B is the one that really matters and at 37.5% it ought to have been welcome by investors. The 260-day volatility on the HHI stock is 49.6%, although primarily one-directional.
All three stocks have had a strong run this year with HHI up 247%, HMM up 118% and KCC having just about doubled. This likely explains why the issuer wasnÆt too concerned about launching the deal on a day when all three stocks declined for the fourth straight session. One source also notes that the 20bp decline in the US dollar swap rate to about 4.5% yesterday from 4.7% last Thursday also resulted in a direct saving on the yield, which was probably worth more to KCC than a few extra percentage points on the share price.
ôFor HMM 20bp accounts for more than 10% of the yield, while in the case of HHI it accounts for 7.7%. This is a worthwhile amount of savings,ö he says.
KCC said it will use part of the proceeds from the exchangeable bond to refinance existing debt, which according to MoodyÆs amounts to W357.5 billion ($392 million). The rest will go towards capital expenditures into existing facilities and to diversify its business.
If the bonds are fully converted, KCC will use up all its treasury shares and will also end up divesting its entire holding in HMM. ôThe company isnÆt desperate to sell, but it will be very happy to part with these shares at a further 20% premium. If it cannot do that, at least it will have achieved very low-cost funding,ö the source says.
The HHI shares that makes up tranche B account for only a portion of KCCÆs current stake in that company.
In a note issued during the bookbuilding, MoodyÆs confirmed its Baa2 rating on KCC, noting that the funds raised will improve the companyÆs balance sheet. The projected debt/Ebitda ratio of 2.0 times for the next two to three years is also appropriate for a rating at this level, it said.
ôFurthermore, the fact that KCC's whole stake in Hyundai Merchant Marine is in the form of the underlying assets of the exchangeable bond confirms its commitment to avoid involvement in the race to acquire the old Hyundai Group,ö said Chris Park, a senior analyst at MoodyÆs. ôThis approach is considered credit positive.ö
Part of the reason for the strong gains in HMM this year is attributed to speculation that HHI and related parties were accumulating stock with the aim of eventually launching a hostile takeover. Officials of HMM have recently down-played such rumours, however, saying that any significant increase in the shareholding by HHI would have to be publicly disclosed.