The difficult execution of the Korean government's final divestment of stock in Korea Tobacco & Ginseng (KT&G) last Friday has cast an even more negative pall over what remains of the year's depleted equity pipeline. Many have concluded that if such a defensive stock with one of Asia's most attractive dividend yields has struggled to attract investor interest in the current market, what hope is there for anyone else.
For many, what was most depressing was the fact that while the $229 million offering managed to secure 60 orders, most were very small and the deal got done largely because it was bolstered by a handful of large anchor orders. Two funds alone are believed to have accounted for $90 million of the deal, although on the plus side, they were both said to be value investors rather than the hedge funds speculated in some quarters. In total, four funds accounted for over half the deal.
As one equity market specialist puts it, "International markets have got so bad that few funds are willing to commit until the very last minute. In Europe, the feedback we got was that they've just about given up all hope and told our sales people, 'we're crying over here. You might as well not bother calling us any more'."
This left lead managers Goldman Sachs, UBS Warburg, Dongwon Securities and Hyundai Securities in a very difficult position. Against a backdrop in which major world equity markets have suffered their worst quarter since 1987, the four became caught between the conflicting price expectations of the Korean government and international investor base. They also failed to be helped by the traditionally safe haven status of tobacco stocks, since the sector's most actively traded stock, Philip Morris, fell 30% during marketing on the back of a revised earnings outlook.
Where the Korean government was concerned, the parity pricing it achieved for its previous international equity offering in October 2001, meant it was looking for a repeat performance and at the very least, wanted to sell the stock at a higher level than its last domestic divestment in late June at Won16,200 per share. International investors, on the other hand, were said to be split between those looking for a 3% to 5% discount no matter what the spot price was and those which had absolute price limits at Won16,000 per share.
Equity bankers say that the leads did the best job circumstances allowed and what emerged was a sensible compromise, although there has been considerable debate over what happened in the final run up to pricing, when the company's share price suddenly collapsed from Won17,000 to Won15,850.
Having originally set out to sell a 14% stake via 52.7 million GDRs, the government allowed the deal to be downsized to 35.817 million units and the company used some of its huge cash pile to buy back the remainder. Having initially gone out with a price range at parity to a 5% discount, this was also amended after the company's share price dropped 6.8% in Asia's morning last Thursday just as the deal was scheduled to price.
At $6.4 per GDR, pricing represented a 0.55% premium to a spot price of Won15,850, or a 6.25% discount to the previous day's close. One GDR equals 0.5 shares and there were four co-leads: Deutsche Bank, ING Bank, LG and Samsung Securities.
With 60 investors in a book that closed marginally oversubscribed, geographical distribution broke down 48% US, 31% Europe and 21% Asia. About 60% were said to be new investors, although this is skewed slightly by the entry of the two large anchor orders, neither of which had previously held KT&G stock.
The company's share price performance in the final run-up to pricing, led many outside observers to assume that the book must have been heavily weighted towards hedge funds. This assumption was also driven by the poor state of global primary markets, where hedge funds have remained one of the few active participants.
But others say the Korean government was extremely sensitive about the allocation process and those funds, which stayed in the book after pricing was switched from a discount to premium, were long-term value investors. These were the investors with limit orders and yet many were still prepared to accept a slight premium as they had done detailed valuations and believed in the stock's upside potential.
Another heartening aspect of the distribution pattern was said to be the participation of US houses, which have recently set up international operations. As one observer comments, "This has been something of a recurring theme all year. And it's good to see that even in these markets, they've continued to pursue a diversification strategy."
But the biggest source of debate concerned the company's share price performance on the final Thursday morning and whether the sudden drop could have been avoided if books had been closed at the end of New York trading the previous night. Although different banks adopt a variety of syndicate strategies with Korean GDRs, there is a core group which shut books at New York's close and then use the Asian trading day to conduct what are often protracted pricing negotiations in the hope of being able to allocate in the short window between Asia's close and London's open when the GDR's begin trading. To ease investors' market risk during Asian trading hours, accounts are, however, allowed to adjust their order sizes.
Some, therefore, argue that it was a mistake to have left the book open in Asia's morning and speculate the step was taken because the share price was too high and the order book would have only come together if the deal was priced at the kind of huge discount the Korean government would have found totally unacceptable. Others say this is completely ridiculous and that everyone knew the deal was due to price on Thursday from the outset. Had the book been shut after New York's close on Wednesday, all the hedge funds would have simply shorted the stock the day before instead.
In one respect, timing was unfortunate as Thursday was an option expiry day and there would have naturally been a huge amount of hedging activity. As it was KT&G is said to have traded five times its normal volume, with about 1.1 million shares changing hands. However, in a broader market context, the stock performed more or less in line with a market, which was following a battering in the US. While for example, KT&G was down 6.8%, the Kospi was down 5.8% and when the index rose 0.6% the day after pricing, KT&G rose 0.03%.
On Monday it continued its upward trend and at a closing price of Won16,400, the stock's performance should have now satisfied both the government and the deal's investor base.