KT&G priced at tight end of terms

The Korean tobacco company rolls up demand for Asia''s first major equity offering since September 11.

In what bankers claim to the shortest Korean pricing meeting on record, terms for a $553.23 million government monetization in Korea Tobacco & Ginseng (KT&G) were decided within 30 minutes yesterday (Wednesday). In some ways, such an unusual feat was hardly surprising given that demand for the deal came at the tight end of all indicative ranges, with the DR book closing four times oversubscribed and the convertible book 15 times oversubscribed.

Together the $309.1 million GDR and $244.13 million convertible represent the first combined equity and equity-linked monetization out of Asia and the first instance of a regional company buying back state-owned shares through a convertible structure. Following China Mobile's precedent in October last year, the deal is also only the second concurrent equity and equity-linked deal on record.

The government intended to monetize a 20% stake in the tobacco company through the deal, with the respective sizes of the two tranches weighted towards the straight equity offering despite the huge demand for the convertible, which closed books two days into roadshows.  In the end 11.89% of the government's 77% stake was sold in DR format and 7.96% in convertible format, with the company using proceeds from the convertible to purchase the shares that back it.

Having marketed the DR at a range of parity to a 5% discount, pricing was completed at parity to the company's W17,700 Korean close and a 1.8% premium to a 30 day average. Less than half the international equity offerings from Korea over the past three years have been able to avoid discount pricing to spot, with KT&G's achievement all the more impressive for doing so in the face of a rising underlying stock price.

With one DR unit equaling half a share, pricing was settled at $6.81. There is no greenshoe. Alongside lead managers Credit Suisse First Boston, UBS Warburg, Dongwon Securities and Hyundai Securities, the remaining syndicate members comprise Daewoo Securities, Lehman Brothers, Samsung Securities and Soc Gen.

Where the convertible is concerned, the five-year premium redemption deal was marketed with a 2% to 2.5% coupon, 13% to 18% conversion premium and three year put at 125bp to 175bp over Treasuries. Pricing was settled on a semi-annual coupon of 2%, a conversion premium of 18% and yield-to-maturity of 125bp over Treasuries. Redemption is at 114.26%, with conversion into either GDR's or underlying stock. There is also hard no call for two years, thereafter subject to a 130% hurdle.

Observers report a total of about 400 tickets in the DR book, with a fairly even split resulting in a 35% allocation to the US, 35% to Europe and 30% to Asia. Bankers comment that one striking feature was the lack of ethical issues raised by US accounts, many of whom had refused to consider the stock when the Korean government last attempted a DR in late 1999.

With the convertible, there were a total of 525 orders, with a split that saw 50% go to Europe, 25% to the US and 25% to Asia. Tier 1 investors comprising outright convertible and fixed income funds were said to account for 75% of the total.

Reinforcing a message expounded throughout the marketing period, bankers believe the deal succeeded because it is the perfect defensive stock for the current market environment. "There were probably three main factors that drove investors' reception to the DR," one banker explains.

"Firstly, KT&G reached its 5% foreign stock ownership limit some time ago and this represents a new way to get hold of it. Secondly, valuations are quite compelling against regional comps and thirdly, there is a high dividend yield - 7.89% as of today's close. A number of fund managers told us they couldn t ignore a yield like this, particularly when they need to make sure they conserve some profit in a falling market."

In anticipation of a successful deal, local investors also underpinned the stock between the beginning of roadshows and pricing, with KT&G outperforming the Kospi by 8.8% and the global tobacco sector by 9.5%.

In the credit markets, the Korean bid has remained equally if not more strong over the same period, with the Republic of Korea's benchmark 2008 bond almost at 100bp over Treasuries for the first time in its three-year history. Given that KT&G has never issued debt before, runs a net cash position and is constrained by the Republic's Baa2/BBB sovereign ceiling, demand for the convertible was almost a given.

A high bond floor for an existing IBK exchangeable into KT&G backed by Treasury strips, also meant that the new deal had to follow suit. As a result, the latter's bond floor ranks as one of the highest on record from Asia and gives investors little equity optionality, although more equity upside than its predecessor, currently trading on a premium of 44.2% and bond floor of 103.99%. The $353 million transaction due August 2003 maturity is currently bid at 105.25%, with parity of 73.53.

Together both deals represent 100% of the free float.

The new deal has a bond floor of 97.5%, with a theoretical value of 103.4% based on historical 100-day volatility of 30%. Implied volatility is 20.8% based on a dividend yield of 7.8% and stock borrow cost of 4%.  Based on a credit spread of 150bp over Libor, KT&G has also come flat to the credit default trading levels of KDIC (Korea Deposit Insurance Corporation).

"Funds have been building up large cash position over the last three to four months and are looking for equity protection at the moment," says one specialist. "This deal has hit a sweet spot in the market and bringing it as part of a combined offering has also been extremely rewarding. Going deep into the equity story during roadshows helped to further penetration of the CB universe, while the accelerated bookbuild of an equity-linked deal created additional momentum for the stock."

A second also concludes, "It's been a difficult time for the company. We all knew we had a successful deal after completing the pre-marketing just before September 11, but it's been an uncertain wait since then. But it's paid off and this has to be the strongest order book of any Korean deal I've worked on. Let's hope KT&G's success encourages other issuers back into the market. The demand is obviously there for the right story."

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