After all the controversy surrounding the mandate of the $500 million deal, the deal's launch yesterday (Tuesday) proved remarkably straightforward, though a tiring slog for the lead bankers, one of whom only managed to grab a few hours sleep the night before pricing in a cardboard box beside his desk.
Having initially thought that an exchangeable into Cho Hung and Woori would be completely unworkable, many ECM bankers now concede that the deal has hit a sweet spot in the market, benefiting from the recent upward trajectory of the Korean stock market, tightening bond spreads and credit momentum led by Standard & Poor's sovereign upgrade to BBB+ and Moody's change in outlook from stable to positive. For cash rich investors looking for defensive yield plays, the deal was also said to have provided a relatively attractive structure despite its outward complexities.
Having originally intended to close books after London's close on Tuesday, the date was moved forwards 24 hours by the three leads - Goldman Sachs, JPMorgan and UBSWarburg along with their three local co-managers Daewoo Securities, Dongwon Securities and LG Securities.
Pricing came with a premium redemption structure on a fixed coupon of 2.5%, conversion premium of 18% and a four-year final maturity at 111.2779% yield 147bp over the interpolated Treasury curve or 3.60%. There is also a two-year put, which was also priced at 105.239% to yield 147bp over two-year Treasuries or 2.817%.
Should a Qualifying Public Offering (QPO) occur in either Cho Hung Bank or Woori Financial Holdings, the coupon will drop to 1.75%. If either QPO is triggered before the put date, the put price will rise by an equal amount to the drop in the coupon. Once a QPO has occurred, there is also a call option 18 months after the QPO at 130% of the conversion price. This is determined as the lower of the QPO price, or the weighted average price of the stock over 10 days trading volume post QPO.
If a second QPO is triggered, there are no changes to the terms, except that investors have the option to convert into either Cho Hung or Woori.
Pricing came at the tightest end of indicative terms, which comprised a conversion premium of 13% to 18% and a Treasury spread of 150bp to 180bp, later revised to 145bp to 155bp. The coupon step-down was also marketed on a 25bp to 75bp range.
In essence, the deal is a straight debt offering until a QPO occurs, at which point it becomes an exchangeable. In terms of pricing references, the deal has, therefore, been benchmarked against outstanding sovereign debt. The nearest comparable is KDIC, whose two-year paper is trading in the asset swap market at a bid/offer spread of 150bp over Libor versus an equivalent 95bp Libor spread for the new deal. The Korea Development Bank also has a November 2003 transaction, currently bid at 120bp over Treasuries.
The difference between the two is that KDIC is 100% risk weighted, while KDB is 20% risk weighted. As a result, the new KDIC deal came at a roughly 30bp premium to KDB's straight debt and 65bp through the asset swap level of KDIC debt in a reflection of the option value assigned to the new deal.
A total of about 140 investors were said to have participated, with a rough split of about 45% Europe, 30% US and 25% Asia. By investor type, about 75% of the book was said to be made up of outright and equity funds, with fixed income investors accounting for the balance.
In putting the deal together observers say that the aim was to create a clean structure and one that balanced the Korean government's desire to get reasonable pricing, but not place any restrictions on its ability to allow privatization to occur in either of the two banks. With many going public bonds, investors receive a fixed yield and no equity optionality until a trigger event, at which point they cede some yield in return for greater equity optionality. From the borrower's perspective, normal debt funding costs are maintained until the trigger event at which point, a lower cost of debt funding is secured in return for ceding equity optionality.
In this case, investors are protected right through to the two-year put as any downward adjustment in the coupon is matched by an upward revision in put price. Observers say that the inclusion of a moving put, which marks a first, was the key to enabling the issuer to achieve tighter pricing because it allowed for a greater step-down in the coupon.
For both issuer and investor, the key consideration was therefore how much value to accord the equity option, which acts as an entry price to the stock offering. In a normal exchangeable, investors would expect to pay three to five option points. In the new KDIC deal, they pay a nominal upfront amount for the option pre QPO, but nothing further once a QPO is triggered. This is estimated to range from 0.75 to 1 option point.
Valuing the equity option beyond this is exceptionality difficult, because conversion will ultimately depend on the government's success in privatizing the two banks and ensuring a greater free float. As one participant explains. "It's impossible to make any volatility assumptions because Cho Hung only has a free float of about $400 million at the moment and the government needs to increase this to $1 billion to allow the QPO to occur."
The free floats are the key to a trigger of a QPO, since the government has to achieve a $1 billion liquidity threshold for either of the stocks - two times the value of the notes at the time of pricing. The government can achieve the liquidity threshold either through one jumbo placement or a number of smaller ones, but the last sell-down prior to a QPO must be a minimum of $200 million and be placed with at least 100 non-affiliated institutional events.
In the event that the government decides to privatize either of the two banks, through a strategic sale, investors are further protected through a special put option since this scenario makes it less likely that a QPO will occur. Under the terms of the put, if the government sells more than 25% in either bank through a strategic sale, the notes can be put at accreted value.
In addition to the put option, investors also benefit from dividend protection above 3% and should an ADR or GDR occur for either bank, they have the option to convert into common stock or DR's.
To satisfy the government's desire to pay as much interest as possible in stock rather than cash, the leads also opted for a premium rather than par redemption structure. "This means thereÆs a higher break-even point for conversion," one observer comments. "The effective premium is therefore higher than the optical premium."
Observers believe that the success of the deal underscores the government's determination to make the privatization of the banking system work. Listed bank stocks have also been some of the greatest beneficiaries of the recent rally in the Korean stock market, with Cho Hung closing Tuesday at Won 3,790, up 126% on the year, while KorAm closed up 106.69%. By contrast, the Kospi index is up just over 25% over the same period.
Nearly all of the big equity-linked offerings from Asia over the past 12 months have hailed from Korea and investors have done well in virtually every single case. The Hyundia/Kia transaction, for example, is currently trading at a bid/offer price of 105%/106%, while the IBK/KT&G deal is bid at 107%. Bankers further conclude that the larger size of the Korean offerings relative to the standard Taiwanese fare appeals to investors because there is greater liquidity, in turn boosted by less asset-swapping.