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Nine Dragons offers to buy back bonds at par

The paper manufacturer uses its cash resources to launch a second tender for its outstanding bonds, while cash-strapped Powerchip is forced to pay its CB investors partly in shares.

Hong Kong-listed Nine Dragons Paper is making a second attempt to get rid of its senior bonds which have become more expensive for the company following a ratings downgrade by Standard & Poor's in December last year. The Chinese paper board manufacturer yesterday launched a tender offer through Deutsche Bank for the entire $118.6 million that remains outstanding of its 7.875% bonds due 2013, offering to pay the principal back in full to bondholders who tender before the early deadline on July 22.

This is the second time this year that Nine Dragons has tendered to buy back the bonds. In February/March it bought back 58% of the principal amount outstanding at that time, or $165.177 million worth of bonds, although at that time investors got only 53 cents to the dollar. While bondholders who tendered in the first round, which was arranged by Merrill Lynch, may well get upset that they could have received a lot more money had they held on for just four more months, a source close to the current offer said that any investor who sold bonds in the open market early this year, before the recovery in the secondary market, would feel the same way.

Only a few days before the February tender, Nine Dragon's Singapore-listed bonds were offered at just 30 cents to the dollar and one banker said at the time that they had been quoted as low as 25 cents. By comparison, the bonds were quoted at 86-90 on Wednesday this week before the announcement of the latest offer and yesterday rose to approximately 99.5-100.5, market participants said.

"It is a completely different world today than it was then...the company's ability to finance itself has changed and it is acting rationally and very fairly," the source said, noting that if the company's credit worthiness improves, the coupon may step down again, which would have a negative impact on the returns for the remaining bondholders.

In an announcement to the Hong Kong stock exchange, Nine Dragons said it has sufficient cash on hand to repurchase all the outstanding notes. Assuming all the bondholders accept the tender, the total cost -- including accrued and unpaid interest -- will be $122 million. However, the source said some of that money is likely to come from undrawn credit facilities and, in any case, it is the company's intention to refinance the cost of the tender through bank borrowings. That domestic Chinese banks have started to lend again is therefore not insignificant for the company deciding to have another go at buying back the bonds. However, Nine Dragons, which makes paper and linerboard for packaging products, has also slowed its rate of expansion as a result of the financial crisis, which means it has been able to preserve more cash.

The fact that it can choose to do a second tender -- and that it is opting to make its remaining bondholders whole by paying par -- puts Nine Dragons in a contrasting position to a number of other companies that have been forced to buy back bonds or convertible bonds at deep discounts this year because they don't have enough cash to cover the scheduled repayments.

Powerchip clears one hurdle

One of those is Powerchip Semiconductor Corp, a Taiwanese memory chip maker, which earlier this week completed an induced CB conversion - a rare feature in the Asian capital markets. The conversion, which was arranged by Citi and achieved a 96.5% success rate, allowed the company to pay its CB holders 60% of the redemption amount in shares instead of cash since it lacked the funds to pay it all back in cash as stated by the original terms. The $156.4 million zero-coupon CB matured on June 17.

In order to get the CB holders to accept the offer, the conversion price was first lowered to NT$5.25 per share from an original NT$20.17, which meant they received significantly more shares than they would have under the original terms. The new conversion price is still at a significant premium to Powerchip's current share price, however. Except for one day when it was up 6.8%, the share price has fallen by between 5% and 7% every day in the past two weeks and yesterday closed at NT$1.99 -- a new 12-month low.

Part of the reason why investors are dumping the shares has to do with the poor outlook for the Dram industry amid concerns of continuous oversupply into 2010, but more importantly, there is a realisation that even though the company was able to avert the current redemption problem, the next crisis lies just around the corner as long as the company continues to burn more cash than it has revenues.

In a research note issued on Tuesday this week -- after it became clear that investors holding 96.5% of the 2009 CBs had accepted the induced conversion -- UBS noted that Powerchip is "deeply mired in debt" and argued that it has a limited chance of becoming self-financing within any reasonable timeframe.

"Powerchip's financial position remains precarious, in our view, and we see a significant risk it will be forced to exit the industry, if it does not receive urgent re-financing," analyst Robert Lea said. He added that the company needs to repay another NT$10 billion ($303 million) worth of bank loans by the end of this year -- the maturities of these loans have already been extended by the lenders once -- but had only an estimated NT$2.1 billion of cash at the end of the second quarter.

The company also has another CB maturing in February next year.

Plenty of alternatives to Nine Dragons

By comparison, Nine Dragons looks like health itself, even though the financial crisis has taken a toll on its earnings. It was primarily this that prompted S&P to downgrade its credit rating to BB- from BBB- at the end of last year, pushing the paper manufacturer into high-yield territory. When the bonds were launched in April 2008, the company was viewed as a low investment grade name and the fall below that crucial line triggered an increase in the coupon payments on the bonds to 9.875% from 7.875%. The coupons are paid twice a year, with the next payment date coming up at the end of October.

The total tender consideration is made up of a tender payment of 97 cents to the dollar and an additional 3 cents to the dollar for bondholders who tender by the early deadline on July 22. Most of the bondholders who intend to accept the offer are expected to do so by that date, but the offer will remain open until midnight, New York time, on August 6. The offer isn't conditional on a minimum amount of bonds being tendered.

Because holders of the Nine Dragons bonds will get their money back in full, the acceptance rate of the current tender can be expected to be quite high. This is especially true since there are plenty of alternatives for investors who want to reinvest the money into other bonds with high coupons. For example, there is a range of Indonesian bonds in the coal sector that pay coupons of at least 10%-11% and up to as much as 20%, and in China there are several property developers that offer yields in the double digits, according to the earlier mentioned source. Other high-yielding alternatives with stronger credit ratings than Nine Dragons include India's Vedanta and Singapore-listed Noble Group.

This means Nine Dragons is in a different position than Hutchison Whampoa was with regard to its two tenders, both for multiple bonds with different maturities, which were announced in May and completed in June. For certain of those maturities there were no real equivalents of similar quality available in the market, which meant investors were reluctant to tender them.

Nine Dragons' share price jumped 7.1% in yesterday's trading to finish at HK$5.28, likely in the anticipation that the bond tender will allow the company to reduce its high gearing somewhat and put it in a better position to increase capacity again when demand picks up.

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