Li & Fung taps perpetual as it eyes acquisitions

Li & Fung's $500 million perpetual suggests a large acquisition is ahead and reduces the likelihood of a near-term equity raising, analysts say.
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Private banks provided the bulk of demand for Li & Fung's perpetual
<div style="text-align: left;"> Private banks provided the bulk of demand for Li & Fung's perpetual </div>

Hong Kong-listed garment exporter Li & Fung raised $500 million through a perpetual bond late last week — which some believe signals that a big acquisition is imminent and reduces the likelihood of Li & Fung tapping the equity market in the near term.

Blue-chip name Li & Fung is controlled by brothers William and Victor Fung, and supplies to major US retailers such as Wal-Mart. The company has been on the acquisition path for some time and a perpetual bond makes sense as its balance sheet looks stretched thanks to rising debt levels. Li & Fung is rated A3 by Moody’s and A- by Standard & Poor’s and its hybrid will receive 50% equity credit from both rating agencies.

Already, there are signs that Li & Fung is struggling to maintain its ratings. On Thursday, (when Li & Fung was marketing its deal to investors), S&P revised its outlook to negative from stable. This means that there is more than a one-in-three chance of a downgrade during the next two years.

“We revised the outlook to reflect our view that Li & Fung’s operations and financial performance are unlikely to improve in 2012 over 2011, when the company’s credit ratios were already weak for the rating,” S&P said.

“In our view, recovery prospects remain uncertain for the next 12 months. At the same time, the company has an aggressive growth target for 2013. We believe Li & Fung may need additional funding to support accelerated acquisitions to try and meet its three-year target,” the agency added.

Earlier in March, the company raised HK$3.91 billion ($504 million) from a top-up placement and, according to a source, while it could raise more equity, that would be expensive and dilutive.

Its perpetual, which is callable after five-and-a-half-years, priced at a yield of 6%, at the tight end of the 6% to 6.125% final guidance and 25bp inside the initial guidance. This was equivalent to a spread of 527.6bp over five-year Treasuries.

The structure was similar to the one used by Hutchison Whampoa, but there were a few small tweaks. The step-up halfway through the 10th year is only 25bp and, as a result, Li & Fung did not need to include replacement covenant language (requiring it to replace the hybrid with another equity issue or hybrid with similar equity content). However, the perpetual loses all equity credit from S&P after the step-up, which should incentivise it to call its bonds. There is also a 75bp step-up after 30.5 years.

The deal enabled Li & Fung to widen its investor base — as private banks were allocated 60%. It attracted an order book of $5.4 billion from 173 accounts. Besides private banks, asset managers were allocated 32%, insurers 5% and banks 3%. Asian investors were allocated 87% and European investors 13%.

In secondary, the bonds rose by two points, prompting suggestions that there might have been too much left on the table. However, according to a source, the company did not want to push too hard on pricing given that it was its first perpetual.

HSBC and Goldman Sachs arranged Li & Fung’s top-up placement in March and the company re-hired HSBC but replaced Goldman Sachs with Citi for the perpetual. Li & Fung recently hired Citi’s former Hong Kong global banking head Ed Lam as its chief financial officer and his appointment takes effect on November 5.

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