The first convertible from Korea in nearly a year was priced last night (Tuesday) under the sole lead of Morgan Stanley. LG Electronics (LGE) raised $250 million from a three-year deal, which the company will use to help reduce its gearing levels from nearly 200%.
With Korean bond spreads recently weakened by oversupply concerns, a convertible structure seems to have made far more sense than a high yield bond, which would have extended the group's maturity profile.
Firstly, there are only eight outstanding benchmark equity-linked deals from Korea, of which the most recent was an SK Corp exchangeable last summer. Secondly the global CB market is currently on fire. But thirdly, and perhaps most importantly of all, equity analysts typically have a very high regard for LGE, one of Korea's most liquid stocks with a market cap of just over $6 billion.
The new deal was consequently priced at the tight end of terms after the book closed eight times covered within two-and-a-half hours of launch. Due February 2005, the deal has a zero coupon, zero yield, par redemption structure, with a call option after two years subject to a 115% hurdle and a put option after one-and-a-half years.
The conversion premium was fixed at 30% to the stock's Won53,000 close, the aggressive end of the 25% to 30% range. There is also a $37.5 million greenshoe.
Underlying terms comprise a bond floor of 95.83%, theoretical value of 103.67% and implied volatility of 30.1%. This is based on a credit spread assumption of 160bp over Libor, 1.95% dividend yield, 4% stock borrow cost and 37.6% historic volatility.
Convertible experts consider this spread level extremely tight given LGE's weak credit profile, arguing that at least 200bp would have been more appropriate. At this wider level, the bond floor would be even more aggressive than it already is for such a short-dated deal with little available borrow.
The swing factor, however, is the possibility of a New York listing later this year, which would considerably cheapen terms. The company mandated Citigroup and Morgan Stanley for a $500 million or so deal at the end of last year, but has recently made no comment on when it intends to execute it.
Observers say the book was not really driven by asset swap demand, with only about 25% of the deal allocated on this basis. Instead a large number of pure equity buyers were reported. A total of 140 accounts participated, with a geographical split of 60% Europe, 25% Asia and 15% US.
Most analysts currently have a buy recommendation on the stock, which hit a 52 week high the day before pricing. "Even after the recent rally, we still like the stock," CSFB said in a recent research report, while UBS added that, "LGE's low capital intensity, market share gains and earnings prospects are not fully reflected in the current valuation."
LGE has two main businesses, home appliances and handsets, plus a large number of subsidiaries (72 globally) including a 50% interest in TFT-LCD manufacturer LG Philips LCD. This latter fact is important because there is a significant differential between the group's credit ratios on a consolidated and unconsolidated basis.
LGE currently has net debt of about $1.56 billion on an unconsolidated basis and $7.18 billion on a consolidated basis. As a result, gearing on a consolidated basis stands at a much higher ratio of roughly 173% compared to 37.9% on an unconsolidated basis. Debt to 2003 forecast EBITDA on a group basis is roughly 3.77 times.
In a recent interview with FinanceAsia, CFO YS Kwon said that the group is keen to change this. "LGE's financial structure is not as good as our competitors," he said. "On a consolidated basis, we are weak and my priority is to reduce the debt to equity ratio to below 100%."
Proceeds from the deal will be used to pay down some of the $1.35 billion debt which falls due over the next 18 months. The company is aiming for a gearing level below 50% by 2005.
