Merrill Lynch arranges large CB for Chinese property investor

Six investors buy into the $200 million deal that will partly be used to fund the takeover of a Westin hotel project in Guangzhou.
Mainland-focused property developer and investment holding company Skyfame Realty has issued $200 million worth of convertible bonds in what has the potential to become a transformational deal for the company.

Not only will the funds allow the Hong Kong-listed company to buy 100% of an almost finished construction project in Guangzhou that will include a five-star hotel operated by international hotel chain Westin, but the deal itself exceeds the current market capitalisation of the company.

According to a stock exchange statement issued by the company yesterday, the shares issued upon full conversion will account for 106.1% of the current market cap at the initial conversion price, and as much as 143.3% in case the conversion price is reset all the way down to the floor price.

The CB, which was arranged by Merrill Lynch, was sold to six investors including two Merrill Lynch entities û the bankÆs real estate fund, Indopark Holdings, and its so called principal credit group (PCG) û which will take a combined $70 million of the deal.

Among the other investors are Lehman Brothers Commercial Corporation Asia and DKR Soundshore Oasis Holding Fund which will each buy $50 million, and fixed-income focused hedge fund PMA Investment, which already owns 16% of SkyfameÆs common shares and will now add $20 million of CBs to its holdings. The final $10 million will be taken up by Standard Bank Asia.

ôInvestors like the deal because they feel the Guangzhou real estate market is still undervalued compared with Shanghai and Beijing. In the past several years, real estate price and rents have not been going up as rapidly as in the other two cities so people still see potential,ö says a source familiar with the deal. ôSpecifically for this company, they like the fact that the projects it is trying to acquire are high-quality projects in prime locations in Guangzhou.ö

The CB has a six-year maturity and will pay a 4% annual coupon and a 15% yield to put or maturity. The deal includes three puts that will allow investors to sell back 30% of the bonds after three years, another 20% after 3.5 years and all of their holdings after four years.

Given that the initial conversion price is set at a low 7.1% premium over latest market close of HK$1.26 (March 2) and can be adjusted further downwards through the reset mechanism, the bonds seem far more likely to be converted into equity however. There is also an issuer call after four years, subject to a 140% hurdle to help this along.

The first reset kicks in six months after the closing date at which time the initial conversion price of HK$1.35 can be reduced to match the volume-weighted average price in the 40 trading days leading up to this date if that is lower. This procedure will then be repeated every quarter, although the conversion price can never go below HK$1. Still, that would mark a 20% discount to the current share price, making the CBs look like a pretty cheap option even if the share price fails to perform.

The stock has done well though, gaining 57% in the past 12 months. Before the suspension to sort out this deal on March 5 the share price had fallen 15.4% from a high of HK$1.49 on January 24, but that was all but reversed yesterday when the stock surged 15.9% to HK$1.46 after announcing details of the acquisition and the CB issue.

As a security for the CB investors, $16 million of net proceeds will be put into a reserve account and will be used to pay the interest on the bonds. The entire issue is also secured upon 100% of the share capital of the off-shore entities that hold the Westin project, and SkyfameÆs chairman has pledged the convertible preference shares he will receive as payment for injecting his 29% holding in the Westin project into the listco as well.

Of the remaining proceeds, $80.7 million will be used to pay for the acquisition of a combined 71% stake in the Westin project from two separate entities. The project comprises the 40-storey hotel tower and a 36-storey office and shopping complex. The hotel, which has 440 rooms and will be the first five-star hotel in Guangzhou to be operated by an international hotel chain, will have a soft opening at the end of April. The grand opening is scheduled for June, while the office tower is set to open for business in June or July.

The source noted that over the next few years there will be quite a few new international hotels in Guangzhou, including a Four Seasons, but the Westin will have a clear first-mover advantage.

In addition to this, the company is planning to acquire the remaining 49% it doesnÆt already own in another luxury condominium development in Guangzhou that will include residential units, serviced apartments, a hotel and a community centre. This development, called Zhoutouzui, is expected to be partially completed and ready for occupation at the end of 2009. Another $92.5 million of the CB proceeds will go towards this transaction, which is still at the negotiation stage.

This CB fits into Merrill LynchÆs recent focus on deals that are marketed to a limited number of investors. While some of these deals do not show up in the league tables, this one likely will and will give the investment bank a boost at a time when the volatile equity markets have resulted in no public CB issuance at all Merrill itself helped oil rig contractor Aban Singapore raise $150 million from a pre-IPO CB on February 20.
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