Nine Dragons offers to buy back bonds

The paper manufacturer offers to pay 53 cents to the dollar to buy back the remaining $283.75 million of a bond it issued less than a year ago.

Nine Dragons Paper, a China-based manufacturer of paper and linerboard for packaging products, yesterday launched a tender to buy back the remainder of its $300 million bond issue maturing in 2013, offering to pay 53 cents to the dollar. The move is in line with a trend seen in the Asian straight debt and convertible bond markets over the past few months as companies take advantage of the sharp drop in bond prices, while at the same time offering investors an exit route. But the fact that Nine Dragons' offer comes less than 10 months after the bonds were issued -- and aims to take back the entire issue -- makes it stand out.

The value destruction of Nine Dragons' Singapore-listed bonds has been remarkable with market participants saying they were offered in the "low 30s" at the end of last week -- meaning that investors were willing to sell every $100 worth of bonds for just $30. One banker said yesterday that the bonds have been quoted as low as 25.

By comparison, the two high-yield bonds that were sold by Noble Group and Vedanta around the same time last year are currently offered at around 70% of their face value. At the time of the issue, Nine Dragons ranked as low investment grade with a BBB- rating from Standard & Poor's, but its ratings have come down since then following a deterioration in its earnings.

Victor Hjort and Kelvin Pang, primary analysts at Morgan Stanley, said in a credit outlook briefing yesterday that, given how cheap debt is at the moment, it makes sense for a company like Nine Dragons to buy back its bonds as it will allow it to reduce interest costs, reduce leverage and improve its internal rate of return. Many Asian companies have the capacity to do this as they are typically cash rich. Hjort and Pang estimate that investment grade companies as a group have liquidity lasting into 2010 even at current capital expenditure levels and this can be further improved if they choose to cut bank on discretionary capex as a result of the current downtrend.

And this is exactly what Nine Dragons has in mind. Responding to questions from FinanceAsia, an investor relations representative for the company said that since it issued the bonds in April last year, the firm has slowed down its expansion plans as a result of the global financial crisis.

This means that we "can afford to pay down our debts, which has the effect of lowering our interest expenses as well as debt gearing, both of which are important financial management objectives in the current economic environment", the representative said. The ratings downgrade to BB- from BBB- by S&P in December triggered an increase of the coupon payments on the bonds from 7.875% to 9.875% from the next interest payment date in late April, meaning it will become more expensive for the company to service the debt.

It is a different issue for the bondholders, however, who will have to decide if they want to take a haircut of 47% after holding the bonds for less than one year. Investors who are willing and able to hold the bonds to maturity may still opt to keep them so as not to incur a loss, but anyone deciding to do so must be prepared for the fact that the issue could become highly illiquid if most of the other bondholders choose to accept the offer. Investors who have bought the bonds in recent months may also want to hang on to them for the coupon payments. At a price corresponding to 53% of face value, the 7.875% bonds yield approximately 30%.

However, the Nine Dragons bonds are barely trading now and given how depressed the price was before the launch of the tender offer yesterday, many investors are expected to welcome the opportunity to cut their losses and get at least half of their money back. A similar tender offer by casino operator Galaxy Entertainment in December saw investors tender 45.6% of the company's $250 million floating-rate notes due 2010 at 53% of face value, and 16% of its $350 million fixed-rate notes due 2012 at 45% of face value. The prices were determined through a Dutch auction.

Nine Dragons' tender is done at a fixed price, although the 53 cents to the dollar offer (plus accrued and unpaid interest) is only available to bondholders who tender their bonds before 5pm New York time on February 23. Those who accept the offer after that will receive 48 cents to the dollar plus interest, as the company is clearly trying to incentivise investors to act early. The offer closes on March 9. It is arranged by Merrill Lynch, which also arranged Galaxy's tender in December.

Nine Dragons has already bought back $16.25 million, or 5.4%, of this bond issue in the open market, which means the size of the remaining issue is currently $283.75 million. Assuming that all bondholders tender their bonds at the maximum price, the buy-back exercise will cost the company $160 million. It will fund the offer from internal resources. In addition to the buy-backs, the company said in December that it has also pre-paid approximately $100 million of a $350 million term loan taken up in September 2006 and HK$720 million ($92 million) of a HK$2.3 billion term facility dated June 2007. The covenants on both these loans were also renegotiated.

So far, Galaxy and Nine Dragons are the only two Asian companies to buy back straight bonds through a tender in recent months, while Hutchison Whampoa and Noble Group have been making smaller purchases in the market. And buy-backs have been even more active in the CB market, while the prices are more depressed. Korea's KCC Corp and Olam have both completed CB tenders, while China High Speed Transmission, Macquarie Communications and Olam International have all bought back more than $100 million worth of CBs in the market. And according to Morgan Stanley, another 16 companies at least have bought back part of their outstanding CBs.

While a buy-back through the market allows the company to buy at times when prices are low, the Nine Dragons IR representative said that since the company aims to purchase all the outstanding notes, a tender offer is "the only means" even though it means paying a bit more.

While the reduction in interest costs ought to be a powerful argument for companies to buy back their debt (assuming they have the means to do so), one banker notes that this isn't for everyone. By buying back bonds early -- especially after less than one year -- the company will reduce its ability to access the bond market in the medium-term future, meaning additional funding will likely have to come from either the bank market or equity issues, he says.

"It's a good thing that the company takes some responsibility and provides investors with an exit route, but people will remember these deeply discounted tenders and may not be that keen to buy any potential future bond issues from the company," the banker says.

Nine Dragons, which is controlled by Zhang Yi who for a time after the company's IPO in early 2006 was estimated to be China's richest woman, has also been under a lot of pressure in the equity market over the past year and has lost more than 80% of its market value as the global downturn has resulted in less demand for packaging materials among Chinese exporters. In January it was forced to issue a statement to the Hong Kong stock exchange denying reports that it was on the cusp of bankruptcy. But while stressing that its financial situation was "sound", the company also issued a profit warning last month saying it expects to record a substantial year-on-year reduction in net profit for the six months to December 2008 due to a significant decrease in selling prices and rising raw material costs.

¬ Haymarket Media Limited. All rights reserved.
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