Nice assets, shame about the cashflow

The structure of First Pacific''s debut high yield bond breaks new ground, but is risky for its controlling shareholder.

No one could accuse First Pacific of having a dull credit story. The Hong Kong based conglomerate has a negative net cashflow, and last year underwent a public spat between its executive chairman and its controlling shareholder.

An attempt to sell one of its key assets was blocked by its own executive chairman, even though this would have raised enough cash to refinance the company's debt. As a result of the debacle the company's longstanding CFO and legal counsel (and company secretary) - both of whom were board members - recently resigned.

Adding to the Salim controlled company's problems, by year end the company has to repay about $100 million of debt to ING and inject cash into its Indian mobile phone subsidiary, Escotel for capex.

Hence the decision by new CFO, Paul Wallace to launch a high yield bond. Word of the UBS-led deal started to leak out about three weeks ago, and in the ensuing weeks the yield First Pac is set to pay has been negatively affected by a worsening climate in the bond markets.

The terms of the bond are innovative, with the key aspect of the deal being First Pac collateralising the bond with its 51.9% stake in Indofood. This was necessary because on a stand-alone basis - thanks to its negative net cashflow - only a very limited number of bond investors would be interested in buying First Pac paper. (S&P have rated the bond single B.)

When the deal was initially discussed with investors several weeks ago, the original idea was to launch a three year bond of $150 million with a yield of around 6.5%. Many bankers admit that in the market conditions of that period such a deal may have been possible.

"Investors were buying virtually anything," recalls one banker. However, with the Fed surprising the market with its interest rate policy and a slew of bad data, market sentiment changed dramatically.

With more caution entering the marketplace, investors have started to look at the relative value of the bond versus Indofood's existing US dollar debt. Indofood's US dollar bonds have four years to run and a yield to maturity of just over 7%. The First Pacific bond now looks likely to price at a premium to this.

Key to the deal's success will be private banking money, particularly Indonesian private banking money. Thanks to the collateral backing of Indofood's stock, this particular investor base views the bond as Indofood risk with a bit of yield pick-up.

Indeed, UBS seems to be hoping that some private clients will realise their capital gains on their Indofood position and switch into the First Pac bonds.

The bigger question is whether the deal makes sense for First Pacific's controlling shareholder, Anthoni Salim who has always viewed Indofood as the crown jewel in his empire and would be loath to lose it. Indeed, of First Pac's four assets (PLDT, Escotel, Metro Pacific and Indofood) only Indofood is contributing any cash to the group, via an annual dividend of between $12-13 million. None of the other companies are paying any dividends, with conservative forecasts being that PLDT might pay a dividend by 2006.

It is this situation that led to a negative net cashflow last year. The company had a corporate overhead cost of $9 million and interest expenses (on the ING loan) of $15.4 million. Against that it received dividends from Indofood of around $12 million.

This suggests last year's cashflow deficit was about $12 million. This year the situation will improve thanks to slightly lower corporate overhead costs and the interest costs will also probably come down by a couple of million. A cashflow deficit of about $4-5 million is likely for 2003, with this number looking equally likely next year too - unless PLDT starts paying dividends in 2005.

The proceeds from the bond will be used to repay the $100 million owed to ING and also to advance $14 million to Escotel to fulfill its side of capex commitments with its Indian partner. However, whether $14 million will be sufficient, given the new competitive landscape Escotel is facing, is doubted by some informed observers.

One source estimates about $40 million will be required by Escotel in the near future given the competitive environment it is facing in its local Indian markets.

Assuming First Pac's own estimate of $14 million to be sufficient, that will leave some surplus cash from the proceeds which can be used to plug the cashflow deficit in the next couple of years.

However, the sheer lack of cash in First Pac must be Salim's key concern. That's because the structure of the bond will put the Indofood stake at risk if things start to go wrong with Indofood's stock price or the value of the rupiah versus the dollar.

The structure sees a Mauritius holding company taking enough Indofood stock to cover the value of the bond. Based on First Pac's 51.9% stake in Indofood, and the Indonesian company's current stock price, as well as the level of the rupiah, a $150 million bond would be 3.3 times covered today by the value of First Pac's Indofood stock.

However, should the value of the coverage fall - due to either a depreciating rupiah or falling Indofood stock price (or both) - then some interesting things happen thanks to the bond's covenants. If it falls to 2 times (ie a value of $300 million) then First Pacific has to top the structure up with cash.

If it goes to 1.8 times, First Pac has to immediately refinance the whole bond or else the trustee of the bond has to immediately liquidate the position by selling the Indofood stock in the market.

Clearly, neither of the above is good, but it is obviously the lower 1.8 times coverage ratio that is the real danger zone. And will it be hit? Well, it is eminently possible. Indeed, that number was almost breached on October 15 last year when Indofood's stock was at Rp475 a share and the rupiah at around 9400 to the dollar.

And as to the first trigger, where would First Pac get the cash to top-up the equity collateral? First Pac's CFO, Wallace says several banks are willing to lend $50-60 million against First Pac's stake in PLDT, and this cash could be used for this purpose.

In such a situation, First Pac's total debt will be $200 million, with an additional contingent liability of $92.6 million for guaranteeing Escotel's debts.
With Indonesia being such a volatile place, the chances of the coverage ratios falling are not insignificant. Wallace says as soon as they got to anywhere near 2.5 times (meaning an equity value for the Indofood stake of $375 million), First Pac would take constructive advice on refinancing the bond. But in a situation of a crisis in Indonesia, it should be stated that the freefall in the coverage ratio could be too quick for constructive advice to be gained.

If anyone, including Salim, has learned anything from the Asian financial crisis, it is that when valuations begin falling in Indonesia, they move with exceptional speed. The Bali bombing last year is a good example - and indeed, it was at this exact time that the Indofood stock hit the Rp475 level, as mentioned above.

It should be pointed out that with the failure of First Pacific to sell a stake in PLDT to John Gokongwei last year, the company had no choice but to seek an alternative way to refinance the ING loan which comes due by year end. This bond may be the best and only option, given its other assets, Metro Pacific and Escotel, are problematic. Metro Pacific has a negative net worth thanks to its $234 million debt, and in fact still owes its parent First Pac $20 million of unpaid interest on a loan.

Escotel is not an immediately saleable asset, given it is in the midst of restructuring its considerable debts and according to a local Indian investment banker could only be sold to a rival Indian operator. This banker seemed to think that if it were sold in the near future, the most likely buyer would be Idea Cellular with a price tag of around $40-50 million.

The bottom line about First Pacific today is that it is a company with two good assets (Indofood and PLDT), but with very bad cashflow (a situation which will only improve when PLDT starts paying dividends). In the event that the Indofood stake was ever threatened, it would be a disaster of the highest order for the equity stakeholders.

For bond investors on the other hand, the collateral provides a reasonable comfort level. And with PLDT's results rapidly improving, First Pac may look radically better in three years when the bond matures. At that stage, a refinancing may be possible.

In the meantime, the one person who can't be happy about the current situation is Anthoni Salim who has always held Indofood as the asset closest to his heart and will have to live through the next couple of years hoping Indonesia remains crisis-free. For this anxiety he has to thank his executive chairman, Manny Pangilinan - the man who singlehandledly blocked the sale of the PLDT stake last year, and who is head of both PLDT and First Pacific. Pangalinan deserves due credit for turning round PLDT, but it must be said this achievement runs in stark comparison to the way the once high-flying First Pac (which he created with Salim in 1981) now finds itself in a far from comfortable, let alone ideal, situation.

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