Khazanah opens the books for exchangeable sukuk

The $600 million bond issue has a similar structure to Khazanah's first exchangeable sukuk, but will pay a higher coupon and be exchangeable into PLUS Expressways.
Malaysia's Khazanah Nasional Bhd yesterday opened the bookbuilding for its and AsiaÆs second exchangeable Islamic bond and immediately met with massive demand that left the $600 million issue multiple times covered within hours, sources say.

This early demand is primarily coming from conventional investors, though, as Islamic investors typically need more time to make investment decisions. However, Khazanah, together with joint bookrunners CIMB, Deutsche Bank and JPMorgan, have spent the past four days travelling around the Middle East on a targeted roadshow to educate Middle Eastern investors about this particular issue and Islamic exchangeables in general with the aim of lifting their participation in the deal compared to KhazanahÆs first such issue in September last year.

That issue, which was exchangeable into Telekom Malaysia, attracted about 20 institutions from the Middle East, compared with around 80 conventional investors. In terms of allocations, about 30% went to the former group.

According to industry specialists, a higher participation should be possible this time as investors focusing on Sharia-compliant bonds (also known as sukuks) are more familiar with the instrument this time around, having seen not only the Khazanah trade, but a few offerings by Middle Eastern issuers as well.

ôKhazanahÆs objective is definitely to get more participation and more demand from Middle Eastern investors, which is obvious by the fact that it is offering a higher coupon,ö says one observer. ôThe company has a national agenda to establish Malaysia as a centre for Islamic finance.ö

While Asian investors are happy to buy zero-coupon convertibles or exchangeables, Middle Eastern investors are more used to investing in fixed-income instrument and like the regular coupon payments.

From a structuring point of view this second offering is almost identical to the first one, which was to be expected after that deal proved acceptable for Islamic investors, while at the same time attracting conventional investors to the table. The first deal, which was arranged by CIMB, HSBC and UBS, also took a full 18 months to complete as everything had to be approved by the regulators for the first time. By using the first deal as a benchmark, the current bookrunners have been able to launch this current offering within a month of being mandated.

There are some differences though. The most obvious is that this time the underlying shares are in PLUS Expressway, a toll road company about 66% controlled by state-owned Khazanah. And when calculating the gearing ratio for the purpose of making the underlying company Sharia compliant, the bookrunners are this time using a debt to market capitalisation ratio rather than the debt to total assets ratio that was implemented on the first deal.

The reason for this change, according to one source, is simply that PLUS Expressway is part of the Dow Jones Islamic index, which uses the debt to market cap definition. However, it may make it more tricky for the bookrunners as they may have to adjust the gearing if the market cap moves up or down a lot.

This time around the bonds will also be listed in Dubai (as well as in Hong Kong and in Labuan, Malaysia), which may help attract more Middle Eastern investors.

Like last time, the coupon payments are based on the dividend of the underlying company û i.e. PLUS Expressway û and are called ôannual periodic paymentsö to get around the fact that Islamic bonds arenÆt allowed to pay interest. These payments will range from 2% to 2.5%, according to the term sheet, compared with 1.25% on the first Khazanah sukuk.

The bonds have a five-year maturity with no put, although investors will be able to sell the bonds back to the issuer if the underlying company fails to stay compliant with the Sharia requirements. There is also an issuer call after three years, subject to a 130% hurdle.

The total yield to maturity, or yield to dissolution as it is referred to, is being offered at a discount to the five-year US dollar swaps rate of 30bp to 90bp. Based on the swaps rate on June 18, this would translate into a yield of about 4.7% to 5.3%. The exchange premium will range from 19% to 23%.

The periodic payments arenÆt guaranteed and to protect investors in case PLUS Expressway were for some reason to reduce its dividend payments substantially, there is a sizeable buffer between the annual periodic payments at a maximum 2.25% and the current dividend yield of approximately 4%. Any divident payments above that 2.25% will also be put inot a so called ôsinking fundö for use towards future annual payments to the bond holders.

However, PLUS Expressway has a stated policy to pay 40% to 60% of its net income as dividend, which means this shouldnÆt be a problem unless its profits were to rapidly deteriorate. Together with the governmentÆs aim to make these Malaysia-issued sukuks a success and the fact that Khazanah is the controlling shareholder of PLUS Expressways, bond investors do have reason to feel pretty comfortable about their annual payments not being disrupted, however.

Being a toll road company, PLUS Expressways do have a steady income stream at the bottom of its earnings that is rising in line with the increased use of its roads. However, the compay is not a stranger to growth, having recently taken stakes in two toll roads in Indonesia and India. It is also involved in two new links to the North to South highway that will connect this main artery to the new Kuala Lumpur airport as well as to Singapore.

The deal may include a greenshoe that could lift the total proceeds towards the $750 million that Khazanah raised from its first sukuk exchangeable, but the size of that hasnÆt been determined yet.

The bookbuilding will close on Wednesday (June 27) with the final price expected to be determined on the same day.
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