At the initial size of $500 million, the bond issue was about six times covered, so two days into the week-long bookbuilding, when the extent of the demand became obvious, the deal was increased to $750 million, including a $100 million upsize option.
At the final size, the bonds marked the largest ever exchangeable or convertible issue out of Malaysia, surpassing KhazanahÆs own $414.5 million exchangeable into PLUS Expressways in 2004 to the number two spot. It was also the largest EB/CB issue out of Asia ex-Japan so far this year.
More than 18 months in the making, the fully Sharia-compliant bonds (also known as sukuks) are exchangeable into shares of Telekom Malaysia and provide an opportunity for Khazanah to reduce its just over 40% stake in that company while at the same time helping to promote the market for Islamic finance. Malaysia also brought the first ever straight sukuk bond to market back in 2002.
UBS acted as global coordinator for the offering which was done through a special purpose vehicle named Rafflesia Capital, and was also joint bookrunner together with CIMB Investment Bank and HSBC Amanah.
ôWe spent a lot of time structuring this deal to ensure it was fully Sharia-compliant and to educate investors. This wasnÆt about selling one single deal, it was about making investors comfortable with and aware of this new asset class so that issuers can return with a similar product,ö says Chang Tau Chen, head of investment banking for Southeast Asia at HSBC.
ôThis deal opens the market for exchangeable sukuks, making it a truly landmark transaction,ö he adds.
For all the talk about the innovative structure of these bonds, though, the mechanics arenÆt too dissimilar to a normal exchangeable. The only real difference is that the coupon payments are based on the dividend of the underlying company and are called an ôannual periodic paymentö to get around the fact that Islamic bonds arenÆt allowed to pay interest.
While an obvious way to get around these issues would have been to issue zero-coupon bonds, bankers involved in the transaction say that would have been less than ideal since most investors in the Middle East are primarily fixed-income houses that are used to getting a regular income from their investments.
A lot of work has also gone into ensuring that not only Khazanah but the underlying company too û Telekom Malaysia û complies with the Sharia requirements and to make sure that investors are amply protected should this cease to be the case during the five-year life of the bond. If that happens (which it could if for example the companyÆs gearing increases too much) investors will have the option to sell the bonds back to the issuer under a clause similar to a ôchange of control putö used on most conventional convertibles.
Provisions have been made to strip out non-Sharia compliant income from the dividend stream targeted at the bond holders.
The bonds also include additional protection in the event that Telekom Malaysia should decide to stop paying dividends, in which case there would be no money for the annual periodic payments. These measures include leaving a sizeable buffer between the annual periodic payments, that have been fixed at 1.25% and Telekom MalaysiaÆs current divided yield of almost 3%.
Any dividend payments above 1.25% will also be put into a so called ôsinking fundö for use towards future annual payments to the bond holders.
In the end though, given that Khazanah, which is the investment holding company of the Malaysian government, will still be the single largest shareholder of Telekom Malaysia with more than 30% of the shares the most likely scenario is that the dividend stream will remain intact. The telecom operator has earlier declared its intention to distribute 40%-60% of its future net profits.
According to a Khazanah official, issues like the above made the deal more challenging than the two convertible sukuks issued out of the Middle East earlier this year which bankers not linked to the Khazanah deal say had actually already broken a lot of the new ground for equity-linked Islamic issuance.
ôIn our case the deal involved a third party which means you can never have full control of whether they will continue to meet all the Sharia requirements,ö Ahmad Shariff, a special officer to KhazanahÆs managing director says in phone interview with FinanceAsia.
ôThis also meant that we were not only selling the Khazanah credit story but also partly the equity story of Telekom Malaysia.ö
Despite the time-consuming preparations to ensure the success of this first Islamic exchangeable, Shariff says Khazanah decided to pursue this challenge as the exchangeable structure fits well in with the companyÆs government mandate which is to help re-vamp the Malaysian companies in its portfolio as well as to realign that portfolio by gradually reducing its stake in companies where its has more than enough shares to exert control. The idea is to re-invest the money outside the country for a higher return.
ôExchangeables, which are quite common in the Asian markets, are also very appropriate for Sharia-compliant issuance and the aim was to structure a bond that provided nothing less (than a conventional bond) for normal investors, but which would be able to capture a new investor base,ö
Those objectives seem to have been met as conventional investors, happy for the rare opportunity to buy equity-linked paper out of Malaysia, flocked to the issue. The Middle Eastern accounts needed more explaining about this new asset class, but after a week of intensive education by the bookrunners with a focus on investors in Saudi Arabia, Dubai and Bahrain and a two-day roadshow by the Khazanah management, they too appeared convinced.
In the end, approximately 100 institutions were said to have submitted orders and of those about 20 were from the Middle East. While the bookrunners tried to satisfy both types of clients, there was a clear preference for Islamic investors in this first issue resulting in them getting about 30% of the allocations, according to a banker involved in the deal. The remaining 70% went to conventional investors.
The basic terms of the bonds include a yield to maturity of 5.07%, or 3 basis points over the US dollar five-year swap rate at the time of pricing, which compared with an indicative range of swaps û32.5 basis points to swaps +42.5 basis points. The prospective yield range moved lower during the roadshow as the swaps rate dropped following last weekÆs FOMC meeting.
The exchange premium was fixed at 19% over Telekom MalaysiaÆs volume-weighted average price of M$9.1143 on Wednesday (September 27) after being marketed in a range of 17% to 20%. The stock closed at M$9.15 on Wednesday and was unchanged yesterday.
The bonds were issued at par and are redeemable at 121.4% of face value. There is an issuer call after three years, subject to a 130% hurdle.
The bookrunners used a credit spread of 60 basis points over Libor and a stock borrow cost of 5%, which gave a bond floor of 97% and an implied volatility of 19.6%. The latter was priced above the 100-day volatility of 12.5% and the 260-day vol at 13.9%, although because it isnÆt possible to short stocks in Malaysia, that will be a less relevant valuation metric.
Market watchers also noted that the high bond floor made the equity option look cheap, but said it was likely part of the issuerÆs objective that this be the case.
ôIt is priced to do well and to ensure there will be a market for similar issues in the future,ö one CB banker concludes, noting that the bonds did indeed trade up to about 101% after the pricing.
Chang at HSBC disagreed about the suggestions that the bonds were cheap though, arguing that the fact that it was priced almost flat to the swap curve suggested otherwise.
The two sukuk convertibles done so far are a $1.05 billion pre-IPO CB for Dubai Ports, arranged by Barclays and Dubai Islamic Bank in January, and a $460 million CB for Aabar Petroleum that was arranged by Deutsche Bank in June.
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