LG Uplus, the telecommunications firm that was set up through a three-way merger between LG Telecom and two other group companies in January this year, has sold $300 million worth of bonds convertible into treasury shares. The deal was launched after the Korean market closed yesterday and completed within three hours.
Analysts have noted that a monetisation of the treasury shares, which were created in connection with the merger and account for about 16% of the outstanding share capital, would have a positive impact on the firm’s valuation and perhaps partly because of that, the deal was well received, allowing for the $100 million upsize option to be exercised in full.
Clearly it is in LG Uplus’s interest to see the CBs convert into equity to get the treasury shares off its books and, as a result, the deal has an unusually short maturity of just two years with a put at 18 months. It also features an innovative coupon and dividend protection structure to push investors to convert early.
Instead of paying the annual coupon after 12 and 24 months, bondholders will receive the first coupon payment after six months and the second one after 12 months, with no further coupon payments after that. Similarly, CB investors will be compensated in full for all dividend payouts in the first year, but only for dividend yields above 3% in the second year.
The company’s current payouts translate into a dividend yield of about 4.5% and essentially this structure means that beyond the first year, investors will only get access to the full dividend if they convert.
Of course, these incentives will mean nothing if the share price doesn’t go up and, based on the performance so far this year, that doesn’t look so promising. Having briefly moved above W9,000 in January, the stock has traded mostly in a range between W7,000 and W8,000 since then. Yesterday it closed at W7,360. Analysts are also divided on the near-term upside with 15 “buys”, 14 “holds”, and two “sells” on the stock.
Also, despite its desire for investors to convert, the company didn’t skimp on the conversion premium. In fact, the premium was fixed at launch at 25% over yesterday’s volume-weighted average price of W7,419 – the highest premium for an unhedgeable Asian CB in quite some time – resulting in an initial conversion price of W9,273.75.
That said, the deal was three times covered with orders from about 150 investors. LG Uplus’s status as a solid investment grade credit would have contributed to the confidence, but the deal also had another key thing going for it. All the payments -- coupons, put price, redemptions etcetera – are all linked to the Korean won, although they will be settled in US dollars. This means the CB is effectively won-denominated, although the term sheet refers to it as a US dollar-denominated, dollar/won FX linked and US dollar settled transaction.
This is the first Korean CB to be denominated in won and settled in US dollar, although the structure follows the same principles as the renminbi-denominated and US dollar settled deals that have been issued over the past few years. The reasons are also the same – to avoid having to mark-to-market the equity option embedded in the CB. That it has taken much longer for this structure to appear in Korea, say sources, is simply because international accounting standards are only now becoming obligatory in the country.
In any case, the link to the won means that there is money to be made if the won continues to appreciate and with a lot of people being bullish on Korea, this added to the attraction of the deal.
“This isn’t just an LG Uplus story, they are also selling the Korea story,” noted one source.
However, some buyers chose to hedge the won exposure, presumably because the currency is quite volatile, and Morgan Stanley, which was the sole bookrunner of the CB, was said to be actively providing such a hedge.
As further evidence of the good demand, the coupon was fixed towards the issuer friendly end – at 2.5% -- after being offered in a range between 2.25% and 3.75%.
The bonds were marketed with a credit spread of 200bp, although some investors were said to have preferred a slightly wider spread of 250bp. Assuming a the lower of the two and a 5% stock borrow cost, given that there is no borrow available, the bond floor worked out at 97% and the implied volatility at about 22%.
According to a source, the bonds had a theoretical value of about 101.5. And as of yesterday evening (Hong Kong time) the CB was said to be bid slightly higher at about 101 in the gray market.
Given the lack of hedging opportunities, everyone was essentially buying the bonds on an outright basis, but the short maturity also attracted more equity-focused funds than traditional CB funds, and in particular funds that were already familiar with the name and which had been buying the straight equity, the source said.