Khazanah exchangeable bond raises S$600m

The sharia-compliant bonds are exchangeable into IHH shares and priced with a negative yield following strong demand from conventional investors.
IHH Healthcare is a low-volatility stock.
IHH Healthcare is a low-volatility stock.

About six months after it was mandated, Malaysian investment company Khazanah Nasional finally hit the market with its fifth exchangeable Islamic bond on Thursday. The deal was slightly smaller than initially talked about, but proved a huge success with investors, confirming once again the huge investor appetite for deals backed by strong credits.

The zero-coupon bond, which is exchangeable into Malaysia-listed shares of IHH Healthcare, has a five-year maturity and can be put back to the issuer after three years. It raised S$600 million ($482 million) and priced with a slightly negative yield.

According to a source, the deal attracted about $2.6 billion of demand and 110 investors, which is about twice the number that would typically come into a deal this size. The strong appetite was obvious from the start with the base offering fully covered in just 40 minutes.

The deal was launched at a size of S$500 million plus an upsize option of S$100 million and to make it more appealing to hedge funds, it came with a stock borrow facility that covered 60% of the underlying shares. The stock, which listed in July last year, became eligible for short-selling only recently but sources say there is no stock available to borrow in the market, and hence it isn’t really possible to short it.

It is unclear whether it was actually necessary to provide borrow for a strong credit like state-owned Khazanah, but it has been known for a while that the bookrunners were trying to put in place an artificial facility, potentially as a way to get a better price. The deal also came with S$100 million of asset swaps, which according to a separate source was oversubscribed and helped to quickly guide investors to the indicated credit spread of 140bp.

With the underlying stock trading less than 2% below the record high that it reached a month ago and in an acknowledgment of the fact that IHH is a low-volatility stock, the exchange premium was offered at a pretty modest level of 10%-17% over Thursday’s close of M$4.19. Given the strong demand, the bookrunners had no problem fixing it at the maximum 17%, however. This resulted in an initial exchange price of 4.9023.

The yield was significantly more aggressive, being offered in a range between 0% and -0.25%. It too was fixed at best terms for the issuer at -0.25%, making it the first equity-linked deal is Asia to price with a negative yield this year.

The more modest exchange premium suggests that a negative yield was definitely a priority. Also, the stock has already risen 50% from its IPO price of M$2.80 last year, so Khazanah will still get a good price if the bonds end up being exchanged for new shares.

As part of its ongoing effort to help develop Malaysia’s Islamic bond market, Khazanah once again chose to make the deal sharia-compliant. However, it wasn’t actively marketed to Islamic investors in the Middle East and the source said that the bonds went mostly to conventional CB investors in Asia and the UK.

Unusually, the exchangeable bond (EB) wasn’t offered to the broader European investor base, which sources said was a direct result of a change to EU regulations in July this year that affects the raising of non-debt capital by alternative investment funds. The regulations are primarily targeted at hedge funds and, while Khazanah clearly doesn’t fall into that category, the way a sukuk is structured means that the deal did technically look like a transaction that would come under the new regulations.

UK regulators have already issued guidelines that exempt deals like exchangeable sukuk, while other EU countries have been slower in interpreting the new rules. And since Khazanah would rather not be a test case, the decision was made to market the deal only in the UK and in Switzerland (which isn’t part of the EU).

As noted from the fact that the deal was more than four times covered after the upsize, this did not really have any material impact, however. Also, the EU regulations only affect primary capital raisings so other European investors are free to by the Khazanah bonds in the secondary market.

In terms of the take-up, the bonds were said to have been split fairly evenly between hedge funds and outright investors. The bonds traded up in the grey market immediately after launch, and after the close at 8pm they were offered at 100.875.

The deal was marketed at a credit spread of 140bp and a stock borrow cost of 50bp. The bonds will also be fully adjusted for dividend payments, although at the moment IHH doesn’t pay any dividends.

Based on the final terms and a historic volatility of 18%, this resulted in a bond floor of 92.9% and an implied volatility of 19.7%.

The bonds were issued at par, which means the put price after three years will be 99.25 and the redemption price after five years 98.76. In the sukuk terminology, the put is referred to as an “optional dissolution” while the redemption is known as a “scheduled dissolution”. There is also an issuer call (“issuer’s dissolution”) after three years, subject to a 130% hurdle.

The exchangeable bonds, which are technically called zero periodic payment exchangeable trust certificates, were issued by a company named Indah Capital with Khazanah as the obligor. The Malaysian investment company owns about 46% of IHH, which is the largest listed hospital operator in Asia and the second largest in the world after US-based HCA.

Most of IHH’s hospital beds are in Malaysia, Singapore and Turkey, but it also has healthcare operations and investments in China, India, Hong Kong, Vietnam, Macedonia and Brunei. The company is listed in both Kuala Lumpur and Singapore, but the bonds are only exchangeable into the Kuala Lumpur-listed stock, which is significantly more liquid.

Healthcare stocks are popular with investors, but the strong interest in this particular exchangeable had probably more to do with the shortage of investment grade deals in the Asian equity-linked market. In the past couple of years, all such deals have been massively oversubscribed.

CIMB, Deutsche Bank and Standard Chartered were joint bookrunner for the offering. The stock borrow facility was provided by CIMB and Deutsche, while Standard Chartered was responsible for the asset swaps.

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