Initially, the interest centred on the aggressive terms and the fact that the sizeable deal was launched with only one bookrunner û Morgan Stanley û but quite quickly the attention turned to the grey market where the bonds were quoted below par shortly after the deal hit the market, suggesting it was struggling.
However, Morgan Stanley stood by the pricing and offered credit support both through credit default swaps and asset swaps, which gave investors confidence enough to take on the issue. And contrary to early calls from specialists about the need for the bonds to be re-offered below par in order to get them out the door, the issue was sold at face value. According to sources close to the bookrunner, the $500 million issue plus the $50 million greenshoe was also allocated in full to investors after attracting as many as 78 names. However, it was clearly not a blow-out deal and the book was less than 1.5 times covered when it closed after about four hours.
CB specialists at rival banks did also question the full allocation, with some saying it was almost inevitable that Morgan Stanley was still sitting on a portion of the bonds as the early downturn in the grey market (where securities can be traded on a when-issued basis before a deal has actually been completed) had scared away a large portion of the ôhotö money that may otherwise have helped support the demand.
While such claims arenÆt uncommon and sometimes seen to be ôpart of the gameö on highly contested mandates, traders said the LG Philips CBs were quoted at 99.25 to 99.75 in the aftermarket late in the evening Hong Kong time, which does indicate that the bookrunner would at least have been buying back bonds below par to help stabilise the price. As long as it is using only the greenshoe for this it wonÆt have any impact on the fees, but should the bank need to go beyond that amount it could quickly start to eat away at its profits. Especially since the fee is widely believed to be below 1% - some say even be as low as 50 basis points.
The real test will come when LG.PhilipsÆ shares start trading today though. If they fall, it will put even more pressure on the bonds and likely prompt yet more investors to sell. While sizeable in dollar terms, the CB accounts for only 2.7% of the issued share capital, which means the stock shouldnÆt have to fall in response to potential future dilution. The companyÆs ADRs in New York were trading just over 1% higher overnight, although they would also have been reacting to the sharp gains in the local market on Wednesday, making it difficult to determine the impact of the CB.
After the questionable timing of LG.PhilipsÆ IPO in July 2004 and its first CB in April 2005, the issuer finally seemed to have got it right. Analysts believe the worst is over for the LCD sector as the key players are cutting back on investments to combat falling selling prices and LG Philips said on Tuesday that it expects demand for LCD TV panels to exceed supply in the second half of this year. The company also reported a much smaller-than-forecast first-quarter loss on Tuesday and is expected to return to a positive bottom line in the third quarter at least. This sent the share price 8.2% higher in Korean trading yesterday to a near-six month high and contributed to another record close for the Kospi index.
Lehman Brothers raised its recommendation on the stock to ôoverweightö yesterday, while Merrill Lynch and Macquarie Securities both lifted their target prices..
In addition, there has been a shortage of convertible paper over the past couple of months, which has created pent-up demand for liquid issues like this one. This is even more true when looking at Korea, which has seen only four CBs over the past two years.
ôPrimarily, people like the turnaround story, but there is also a technical aspect to this deal,ö says one observer. ôItÆs a liquid transaction and you can easily trade both the credit and the stock in the market. Both are also hedgeable which brings in the arbitrage players.ö
However, it seems this positive momentum was partially offset by the aggressive terms, which included a 40% conversion premium (the initial offering range was 40% to 45% over yesterdayÆs close of W35,050) and a tight credit spread of 150 basis points. Bankers cited the competitive bidding for the mandate as a key reason for such terms, but stressed that at least a couple of other banks were believed to have been very close to the terms offered by Morgan Stanley.
What raised the most interest in this respect was the fact that Citi passed on the opportunity to be at least a joint bookrunner on the deal. The investment bank had been working as a financial adviser to LG Philips for some time with regard to this particular CB and had a first right of refusal to match any bid from rival banks. Sources said it appears to have been the valuation of the credit that ultimately made Citi walk away.
At 150 basis points, the credit spread is in line with that used on the previous $475 million bond two years ago, one source says, noting that that shortly after that issue was completed the credit spread tightened to 130 basis points. At the time, other sources said they used a credit spread closer to 170 basis points, however.
ôThis could have been a much better deal, but between the company and the bookrunners they decided to launch with terms that were on the aggressive side,ö says one observer. This cooled down a lot of the ôhotö money that would otherwise have bought in and left the whole thing a lot more uncertain.ö
The zero-coupon bonds have a five year maturity and can be put back to the company after three years at 109.7% for a yield of 3.125%. They were marketed with a yield range of 2.625% to 3.125%, although given the muted demand it was pretty clear early on that both the yield and the conversion premium would end up at the generous end.
The 8.2% rally in the share price could have become an issue since it effectively added to the conversion premium, but because the price ô went up for a good reasonö most investors actually regarded it as a ôreal levelö and didnÆt even raise the question, one source notes.
Unusually, the bonds cannot be converted in the first year as a result of the a new regulation in Korea, but given the high conversion premium this is unlikely to have much practical impact û although it does of course reduce the flexibility of investors somewhat. There is a standard three-year issuer call.
The underlying assumptions included a bond floor of 90.4% and an implied volatility of 32.6%, which compares with a 100-day volatility of just over 34%. Aside from the credit spread, this is based on a 2% stock borrow cost (the stock has become more widely available for lending since the last CB when the stock borrow was assumed at 5%) and a 1% divided yield.
LG Philips didnÆt specify what it will use the proceeds for, saying only that it will go towards general corporate purposes and capex. However, sources close to the deal said it is possible that some of the money will be used to buy back the outstanding convertible, which will become putable in October and is currently trading well out of money. The conversion premium, which was fixed at 30% at the time of issue, is now trading at 61%, making it highly unlikely that investors will hold on to it for a possible conversion later on.
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