Khazanah times its $321m exchangeable to perfection

Malaysia’s sovereign fund sells $321 million of sukuk exchangeable into Hong Kong-listed Citic Securities amid a strong run in the underlying stock.

Malaysian state investment fund Khazanah Nasional took advantage of Hong Kong’s red-hot stock market to issue $320.8 million worth of sukuk exchangeable into Citic Securities’ H-shares, extending its recent practice of issuing Islamic exchangeable securities almost every year.

Khazanah has become the only source of equity-linked sukuk since 2010 when the last corporate issuer, YTL Corporation, issued a $350 million convertible note. As it stands, there is now no outstanding equity-linked sukuk in the market except Khazahah’s recent issues.

This prolonged drought of issuance makes Khazanah even more important in terms of providing liquidity in the Islamic sukuk market, as well as retaining Malaysia’s influence as a top spot for Shariah-compliant securities.

Khazanah has issued three exchangeable sukuk in the last five years. It raised over $1.3 billion from the sale of bonds exchangeable into shares of Beijing EnterprisesTenaga Nasional, and IHH Healthcare in 2016, 2014, and 2013, respectively.

The sovereign fund first proposed the sukuk issue in April last year and it has taken nine months for the deal to materialise. This was partly attributed to the relative weakness of Malaysian equities compared to the rest of the region last year, making an exchangeable sukuk with a Malaysian stock less practical from a profitability point of view.

Khazanah eventually picked Hong Kong-listed Citic Securities, China's largest brokerage, into which it invested $300 million as part of its $3.5 billion private share placement in 2015, as the underlying security for the five-year exchangeable sukuk.

Timely sale

The zero-coupon sukuk has a fairly standard structure that includes a three-year put option and full dividend pass-through.

Khazanah might not have hoped for a better time to execute the deal, as it was launched on the back of Citic Securities’ 8% gain on Wednesday. Year-to-date the stock has soared 21% and heavily outperformed the Hang Seng Index’s 7% gain.

Stock market investors are bullish about Chinese banks and brokers because they had largely lagged behind the broader market last year. Such strong run has offered an opportunity for Khazanah to potentially cash out the investment for a profit.

In 2015 Khazanah bought Citic Securities shares at HK$24.6 per share. While the shares were still trading below that level at HK$19.5 when the sukuk issue hit the market late Wednesday night, Khazanah could potentially exit the investment at HK$26.56, the level where the final exchange price was settled.

That represented a hefty premium of 40% over Citic Securities' volume weighted average price of HK$18.9722, and 36.2% to its Wednesday close. During bookbuilding, the sukuk was marketed at a premium range of 35% to 40%.

Aggressive terms

One source familiar with the situation said the sector's bullish run helped add momentum for the sukuk issue and allowed the issuer to push for pricing at the tighter end.

In the end Khazanah received over $1.75 billion of demand from 78 accounts, an extremely strong book considering that the company has not sounded out investors before the official launch and offered no official stock borrow.

From a pricing perspective, Khazanah’s new sukuk was priced much tighter than Country Garden’s $2 billion convertible bond issued a day earlier.

Based on a credit spread of 85 basis points and a 50bp borrow cost, Khazanah’s new sukuk was issued with underlying assumptions of a 91% bond floor and an implied volatility of 29% at the final price, which was much higher than the stock’s 30-day historical volatility of 22% before the strong surge this week.

Meanwhile, Country Garden’s deal was sold at an implied volatility of around 21% compared to its historical volatility of 63.6%, implying that its option value was much cheaper.

The final order book was fairly evenly split between outright and hedge funds, according to the source.

Should the sukuk be fully exchanged, Khazanah will cease being a shareholder of Citic Securities. It has a 0.8% stake in the Chinese broker.

CIMB and JP Morgan were joint bookrunners on the transaction.

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