KT&G outlines indicative terms

The Korean government will seek a slim discount for the DR portion of its combined equity and convertible monetization.

Roadshows begin in Hong Kong today (Thursday) for a roughly $500 million deal, which will price in New York on Wednesday October 24. Led by Credit Suisse First Boston, UBS Warburg, Dongwon Securities and Hyundai Securities, the unusually structured structured transaction was originally scheduled to begin presentations two days after the terrorist attacks in the US on September 11.

Despite the fact Asian markets have sold off since that date, indicative terms remain unchanged and the lead managers hope that a successful offering will re-energise the region's lifeless primary markets. In monetizing a 20% stake in Korea Tobacco & Ginseng, the government hopes to sell part of its stake in DR format, with KT&G using proceeds from the convertible (issued in its name) to purchase the remainder. However, the respective sizes of the two tranches will only be decided on the day of pricing and the lead managers plan to run separate books to maintain competitive and price tension.

This DR is being marketed on a range of parity to a 5% discount. If successful, this should place the deal at the tighter end of terms achieved by the government over the past three years, despite the latter's oft-cited reluctance to price national assets at a cheaper price to foreigners than local investors are able to buy them domestically.

Since the beginning of 1999, there have been 10 ADR and GDR offerings out of Korea, of which only three have secured premium pricing to the company's spot price in the domestic market - Korea Telecom in July 1999 (20.3%), Korea Telecom in June 2001 (0.35%) and Kepco in April 1999 (2.4% to underlying). One company has secured parity to its underlying - ironically it was Hyundai Electronics in the autumn of 1999. Six companies, meanwhile, have been priced at discounts to spot  - Posco in September 2000 (1.24%), Shinhan Bank in June 1999 (5.8%), Samsung Display Devices the same month (8%), Hyundai Motor in September 1999 (15.85%), Hanvit Bank the same month (21%) and Hynix in June this year (24.5%).

Bankers say that they have been encouraged by pre-marketing feedback, and the resilience of KT&G's share price over the past couple of weeks. Having traded at a W16,900 level just prior to September 11, the stock closed Wednesday at W17,950. Over the same period, it outperformed the Kospi index by 13.6%, although year-to-date it remains down 5.53%.

This strong performance has been attributed to the defensive nature of the stock, one of the main selling points of the forthcoming issue alongside a high dividend yield. Bankers say that KT&G should be attractive for cash rich funds looking for a defensive investment and particularly as the 5% foreign ownership limit is already full. With trading volume of only about $2.5 million per day, the stock has also always been hampered by a small free float.

Terms for the convertible remain exactly as they were pre-September 11. There will be a coupon range of 2% to 2.5%, a conversion premium of 13% to 18%, and a three-year put at 125bp to 175pb over Treasuries. With a five-year premium redemption structure, the deal also features hard no call for two years, thereafter subject to a 130% premium. There are no re-sets.

Underlying assumptions are based on a credit spread of 150bp over Libor and dividend yield of 7.8%. This gives a bond floor between 97.2% and 98.6%, with theoretical value between of 100.7% to 102.9%. On a 100-day volatility basis, the stock averages 37%, with implied volatility of 14% to 20% based on a stock borrow cost of 4%.

At these levels, KT&G will rank second to the Republic as the tightest credit benchmark in the Korean universe. Its nearest comparables are the Korea Development Bank (KDB) and Korea Deposit Insurance Corporation (KDIC). In the credit default market, the former is trading on a bid/offer spread of 150bp/160bp over Libor, while the latter is bid at 165bp over. Both are about 10bp to 20bp wider than where they were pre-September 11.

KT&G commands Korea's Baa2/BBB sovereign rating, although as observers are keen to point out, Moody's has commented that it is constrained by it. On a stand-alone basis, few would argue that KT&G has one of the strongest balance sheets in the Republic and runs a net cash position ($607 million at the end of 2000). Indeed, the company currently has no interest bearing debt at all on its balance sheet, a factor that is likely to make the convertible extremely popular with asset swappers.

"This credit should definitely command a premium to all around it," one specialist relates. "There is, for example, already over a $1 billion of paper from KDIC out in the market, whereas this is a new entity. KT&G is also not exposed to a number of Korean companies as KDIC is. This company is a cash cow and one whose fortunes are not tied to the wider Korean economy."

Other syndicate members for the deal comprise Daewoo Securities, Lehman Brothers, Samsung Securities and Soc Gen.