Olam re-offers CB after investors baulk at aggressive terms

The soft commodities supply chain manager is forced to increase the coupon, lower the conversion premium and re-offer the deal at 98% after the bookrunners get the pricing wrong.

Olam International late last night revised the terms on a $400 million convertible bond that it offered to the market in the mid-afternoon after investors deemed the original terms too aggressive. The revisions resulted in a higher coupon and a lower conversion premium and, on top of that, the bonds were also re-offered at 98% of par to all investors, making this the first Asian CB since 2007 to be re-offered.

However, the original structure with a seven-year maturity and no put was kept in place, which means Olam, a Singapore-listed integrated supply chain manager of agricultural products with a direct presence in 60 countries, was able to raise financing to match the new six-year strategy that it outlined last week.

J.P. Morgan and Standard Chartered who were joint bookrunners for the deal (albeit with the economics split 75-25 in favour of J.P. Morgan), had to give up their entire 2% fee as a result of the re-offer, but at least they didn't lose any money and weren't stuck with any bonds as investors were happy to buy at the revised terms.

The deal did in fact end up being multiple times covered -- at the re-offer price -- with slightly more than 50 investors said to have participated. After pricing, the bonds also traded up to about 99%.

One source noted that the bookrunners got this one wrong and said they had been aggressive in launching the deal without pre-sounding the market and without securing the support of a few anchor investors. However, they probably chose "the right company" on which to get it wrong, since investors like the name and have a lot of confidence both in Olam's long-term strategy and in its CEO -- hence it is a company they wanted to invest in once the terms became more favourable, the source said. Had the bookrunners been dealing with a different company, they may well have been forced to pull the deal altogether after misjudging what terms would be acceptable to investors.

According to the initial term sheet, the CB was offered with a coupon range of 4.5% to 5.4% and no back-ended yield, and a conversion premium between 28% and 35% over yesterday's volume-weighted average price of S$2.4682 -- a price that was virtually identical to the last traded price of S$2.47 before the stock was suspended at 2pm Singapore time.

The response from investors was that the coupon was too low and the premium too high, especially considering that Olam's share price has already risen 180% since early December last year -- and the bonds quickly fell to about 99 in the gray market. This may have been bad enough, but potential buyers also took issue with the maturity, arguing that seven years without a put option (there is an issuer call after five-year, subject to a 130% hurdle) is too long for an unsecured deal from a company that has no credit rating and no five-year bonds in the market to provide visibility on the credit.

One observer noted that this would effectively put the CB behind all of the company's other debts, including a CB due in 2013 that is deep in the money, which have shorter maturities. Only last week, the company secured a fully underwritten $540 million term loan from a group of banks that was split on one three-year and one five-year tranche. Of the company's S$3.2 billion ($2.2 billion) of borrowings, more than 60% is due within one year.

Perhaps because of that lack of visibility on the credit, the bookrunners and the potential investors took a very different view on what credit spread to use. The former suggested 550bp, while investors and analysts favoured a significantly wider spread of 650bp-700bp -- even 800bp was mentioned.

On top of that, the 1%-2% stock borrow cost that was guided by the bookrunners was thought to be too low. Sources said the number of shares available for lending appeared to shrink once the CB was in the market, almost as if someone had bought up a lot of the stock at the last minute. Investors who chose to feed their models with a higher credit spread and stock borrow cost found that the deal was not attractive at the provided terms.

Using a credit assumption of 700bp, a stock borrow cost of 3%, a 35% volatility (versus a 100-day historic vol of 53%), and assuming a 3% drop in the share price on the first day after the deal, a London-based CB analyst arrived at a theoretical value of 94.3 to 100.6 with a bond floor of 72.7% to 77.2%. Paying par for something with that low a value obviously would not be very attractive.

The analyst also noted that the Olam CB compared unfavourably to another recent CB in the same sector, the $100 million deal issued by Singapore-listed palm oil producer First Resources last week. That deal pays a slightly higher coupon of 5.625%, has a back-ended yield of 6.375% and a conversion premium of 23.5%. It also has a five-year maturity with a two-year put, making it a lot less risky for outright investors -- a group of investors that have become the major buyers of Asian CBs in the past year and which were viewed as the only possible buyers of the Olam deal under the original terms, given the stretched valuations and limited stock borrow.

After a renegotiation with the company, the bookrunners returned to investors late last night with a new set of fixed terms. The coupon was increased to 6% from 5.4% (top of the earlier range) and the conversion premium was lowered to 25% over the VWAP from 28% previously (bottom of the earlier range), for a conversion price of S$3.085.

Some market players had earlier said that they wanted an even higher coupon, but in combination with the lower premium, 6% turned out to be sufficient. The investor confidence may have been boosted by the fact that Olam enjoys the support of Singapore investment firm Temasek, which took a 13.8% stake in the company three months ago to become the second-largest shareholder.

According to a source, the final allocation contained a better mix of outright buyers and hedge funds than had been anticipated under the original terms, although the outright portion did still clearly outweighed the demand that came from hedge funds aiming to extract value by going short the underlying equity.

Outright investors, who typically come into a deal because they believe in the equity story, were no doubt influenced by the good reception to Olam's revised strategy for the coming six years which CEO Sunny Verghese outlined in connection with the company's results for fiscal 2009, ending June 30. The plan includes a target to double Olam's intrinsic shareholder value in each of the next two three-year cycles. The company also plans to invest to achieve an even more integrated value chain; selectively expand into value chain adjacencies; to optimise and extract full value from its core operations; to build on latent assets such as its packaged food business and its commodity financial services group; and to downsize or exit unattractive businesses and activities.

By 2015, Olam aims to have improved its gross profit margin to 4% from 2.2% in fiscal 2009.

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