Leung gets optimal pricing from vendor financing

Frances Leung couldn't have gotten such attractive pricing had he gone to the region's commercial lenders.
There has been a lot of conjecture made in recent days regarding former Hong Kong financier Francis LeungÆs acquisition of a 23% stake in PCCW. Leung is set to acquire the stake in PCCW held by Singapore-listed Pacific Century Regional Developments (PCRD) at HK$6 ($0.77) per share, a total consideration of HK$9.2 billion ($1.2 billion).

Furthermore, Richard Li through PCRD has agreed to lend HK$6.4 billion ($820 million) to Francis Leung to partially finance the acquisition. The funds will be lent with an annual interest rate of 6.5%.

In reality no cash will actually exchange hands for the time being, the $6.4 billion loan is nothing more than a legal agreement between the two parties allowing Leung time to put together financing before two of the three payment considerations need to be made.

Leung has agreed to purchase the stake via three stages. An initial HK$500 million ($64 million) will be deposited to PCRD immediately followed by 30% of total consideration not later than end of November. The second stage will entail a payment of HK$780 million ($100 million) 12 months after the initial deposit is made. Finally 18 months past the first payment, Leung will pay out the remainder.

Although, it is yet unknown what the tenor of the loan is, at 6.5% Leung is borrowing funds at a rate that is significantly better than what he would get in todayÆs bank market.

Given the underlying fundamentals of the deal, any bank loan that Leung could acquire domestically would likely seek a coupon of a no lower than 7%.

The key questions most lenders would look to answer in a deal like this would be if they are comfortable with the security position and buffer, the borrowerÆs ability to get out whole if it things go wrong and finally if the interest can be serviced in a reliable manner.

Most analysts estimate that a similarly structured bank loan would expect to pay a minimum rate of 250bp to 300bp over the cost of funds - effectively 3-month Hibor, which was quoted at 4.465-4.5% yesterday (June 12).

Additionally, as the Li / Leung loan is similar in structure to a bridging loan, any such bank facility would seek to encourage the borrower to refinance the deal in as short a time as possible. This is usually done via step-up structuring, such as an increase of 25bp to 50bp increments every three to six months.

Under these conditions, 6.5% begins to look very attractive. Most commercial lenders would be happier to lend against cashflow - such as would have been the case if the assets had been purchased by Macquarie. With stock, the only cashflow is from dividends.

Additionally when lending against stock there are issues as to the ability to sell out of the position during stress scenarios, in order to service the loans.

All in all, it looks as though Leung has gotten the best possible deal by seeking vendor financing through Li and PCRD. The question everyone is now pondering is what, if anything, will happen next? It is hard to believe that the financing story will end here.
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