Larsen & Toubro tackles floor price hurdle with QIP/CB combination

The Indian infrastructure play raises $600 million, of which two-thirds comes from the sale of new shares at a 1.1% discount. Separately, Welspun increases its recent CB to $150 million.

Larsen & Toubro (L&T), India's largest engineering and construction firm, yesterday raised $600 million from a combination of a qualified institutional placement (QIP) and five-year convertible bonds, which allowed it to get around the hurdles imposed by India's floor price regulations. The QIP and the CB were both launched with fixed terms and placed with a small group of investors.

By structuring the convertible bond with terms attractive enough to appeal to investors, including a conversion premium of just 15%, and by requiring those who subscribed for the bonds to also put in an order for the equities, the company was able to get away with pricing the equity at a discount of just 1.1% versus the latest market price. This was the largest discount possible, based on the current market price, since the issue price on the equity was already equal to the minimum price allowed by Indian regulations -- also known as the floor price.

Indian follow-on share issues, including QIPs, cannot be priced below the average closing price in the previous two weeks. While intended to protect minority shareholders from the potential dilution caused by controlling shareholders buying new shares at significant discounts, the rule means that, in a falling market, the floor price is invariably higher than the current market price. This has made it extremely difficult for Indian companies to sell new equity and has led to a long list of issuers waiting to come to market on the one day their market price happens to move high enough above the floor price to make a new issue attractive to investors.

L&T had been one of these backed-up issuers for some time, but the clever structuring of this deal enabled it to jump the queue even though its share price fell 0.7% over the four days leading up to the transaction. The company intends to use the money for capital expenditure and acquisitions among other things. It has recently made forays into capital intensive sectors such as railways and defence, and in a presentation to investors last month said it is also gearing up for opportunities in nuclear power, having signed MOUs with four separate nuclear power producers in the US, Canada and Russia.

While it may not be possible for all Indian companies to copy this trade, as the success would have been partly down to the fact that L&T is such a well-respected name, but sources projected last night that several other issuers in the pipeline will now be exploring a similar combined transaction to get around their floor price hurdles. This may even help ensure the Indian CB market remains active after being re-opened after 18 months by two separate issues a couple of weeks ago.

The deal was structured by Citi and allowed the US investment bank the privilege of arranging the transaction on a sole basis. According to market talk, L&T had initially mandated Bank of America Merrill Lynch and Morgan Stanley alongside Citi to carry out a $600 million follow-on. It later dropped the first two and brought in Credit Suisse and Nomura to replace them, but when the combined QIP and CB hit the market shortly before the Indian opening yesterday, Citi was the only bank on the term sheet.

The convertible bond was the smaller of the two "tranches" at $200 million, but by marketing it to investors as a package, with the requirement that investors had to put in an order for shares equalling twice the amount (in dollar terms) of bonds they wanted, the company was able to ensure that the larger -- and less attractive -- equity offering was not left out in the cold.

As it were, though, the QIP received a number of orders from long-only investors who requested only equity, which enabled the bookrunners to steer the allocation of the shares away from investors who were thought to be in it primarily for the CB and could have been expected to dump the shares right back into the market. As a result, about 20 investors participated in the QIP, while the CB went to about 10 accounts. Most of the buyers were based either in India or Asia, which isn't surprising given that the deal was in the market in the Asian morning. The combined book included both long-only investors and hedge funds.

In fact, the order book was open for just 30 minutes, right before the start of trading in the Indian stock market (the books opened at 11.55am Hong Kong time). The late launch (an effect of the stock exchange approvals dragging out) would certainly have made the deal somewhat stressful for the bookrunners -- if the deal hadn't been completed before the Indian open at 12.30pm Hong Kong time, they would have had to finish it off against a live market, which would have made it a lot more challenging. However, sources said unofficial marketing had really started the previous night and there were enough anchor orders and indications in place at launch to make the bankers comfortable that the deal would go through.

The $400 million equity tranche was offered, and sold, at a price of Rs1,659.3 per share, which translated into 11.3 million new shares or 1.9% of the existing share capital. As noted earlier, the price equalled a discount of 1.1% versus Wednesday's close of Rs1,677.25 on the National Stock Exchange.

The $200 million CB tranche offered a 3.5% coupon and a 15% conversion premium over the QIP price, resulting in a conversion price of Rs1,980.20 -- a level where the stock last traded at the end of September last year. The bonds were issued at par and will also be redeemed at par, meaning the 3.5% coupon is also equal to the yield-to-maturity. There is an issuer call after three years, subject to a hurdle of 130%.

The bonds were marketed with a credit spread assumption of 350bp-375bp and the conversion price will be adjusted if cash dividends exceed either a dividend yield of 1% or 115% of the previous year's payout. This resulted in a bond floor of about 88%-89% and an implied volatility of 27%-28%, according to specialists.

Aside from the low premium, the CB was also deemed to be attractive because of a perceived scarcity value. L&T last issued a convert in 2006 and all its previous CBs have already been converted into equity. And given that L&T is considered one of the best proxies for the Indian infrastructure build-out, there is clearly a lot of interest in the stock. Before this transaction, the company's share price had tripled from a low of Rs562.05 in March, significantly outperforming the 106% gain in the benchmark Sensex index in the same period.

The share price held up quite well after the deal yesterday as well, falling only 1.6% to Rs1,650.8. The CB traded up to 106-106.5, which gives some indication not just of the scarcity value, but also of how generous the pricing had to be in order to draw investors into the equity issue.

Still, at an annual coupon of 3.5%, L&T will not be paying excessively even if the bonds don't convert into equity. Iron ore mining company Sesa Goa, which was one of the two Indian companies to price a CB two weeks ago, is paying a coupon of 5%, while the second issuer that day -- Welspun Gujarat Stahl Rohren, a manufacturer of steel pipes for energy transportation -- is paying an annual coupon of 4.5% plus a back-ended yield to maturity of 5%. Both companies are viewed as weaker credits than L&T, however.

Separately, Welspun exercised the remaining $20 million portion of its upsize option late Wednesday, increasing the size of its five-year CB to $150 million. At the time of the size increase, the bonds were offered at a price of 101.5. The Welspun bonds were brought to market by J.P. Morgan, while the $500 million Sesa Goa issue was jointly arranged by Goldman Sachs and Morgan Stanley.

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