An active day for the US investment bank, Thursday, with the completion of an upsized $450 million convertible for PCCW and launch of a $175 million convertible for Taiwanese IC packager and tester Siliconware Precision Industries.
Rumours that Morgan Stanley was quietly pre-marketing an equity-linked deal for PCCW first began circulating on Tuesday following the completion of the telecommunication group's private placement convertible with Intel the previous day. A large number of rival bankers were, nevertheless, mildly surprised when a deal did emerge yesterday (Thursday), since many have tried and failed to launch deals for the group since the completion of its $750 million bond issue via JPMorgan in November.
In December, for example, the group pulled back from attempts to launch euro and sterling bond issues via Barclays, Salomon Smith Barney and UBS Warburg after investors became incensed that it was returning to the debt markets within days of saying it had no intention of doing so.
Similarly, Goldman and later HSBC's soft marketing of a hybrid debt instrument that would masquerade as equity on the balance sheet came to naught. As APP had successfully demonstrated before the financial crisis, the structure is ideal for companies needing to raise debt funding without pressuring debt ratios. In this instance though, it is thought that pricing would have been too prohibitive given investors' renewed concerns about lack of transparency at the group and its propensity to push out deals no matter what their impact on the ones before.
Consequently, many bankers believed the group was moving out of active deal mode and adopting a new strategy of re-building bridges while awaiting better pricing conditions. This attitude was further re-forced by the fact that PCCW is now down below the crucial 3.5 times debt to EBITDA trigger which will allow it to dividend up 75% of profits from subsidiary to parent come year-end in March. Under the loan covenants of the $4.7 billion syndicated loan it used to finance its take-over of Hong Kong Telecom, any level above 3.5 times would restrict dividend payments to 35% of profits.
Morgan Stanley bankers, therefore, describe the convertible bond as a small but important new step in the re-molding of PCCW's capital structure at a time when it has no pressing need for funds. Paul Aiello, the bank's co-head of telecom investment banking says the deal marks, "a great opportunity for PCCW to access the capital markets in an intelligent and cost-effective way as part of its overall de-leveraging plan."
Because the group is now below the 3.5 mark, it is said to view the convertible as a means of reducing its cost of capital and enhancing its financial flexibility. In terms of reducing overall debt levels it will have a neutral effect, since the deal is guaranteed by the operating company whose loan it re-finances. So too, a five-year maturity only marks a one-year extension to the debt maturity profile, since the $1.99 billion second tranche of the syndicated loan falls due in 2006.
What the transaction does do is reduce the group's interest payments by about $20 million since it pays a lower cash coupon of 1% and has a premium redemption structure.
Final terms came in the middle of the pre-marketed range and comprise an issue size of $450 million with a five-year final maturity and three-year hard no call thereafter subject to a 130% hurdle. With a coupon of 1%, the conversion premium was set at 23% over a closing share price of HK$2.225, while there is a 4.5% yield-to-maturity, representing a spread of 33bp over Treasuries. Indicative pricing had been pitched on a 20% to 25% conversion premium and yield of 4.25% to 4.75%. Redemption is at 119.4% and there is also a 15% greenshoe, which could bump the deal size up to $517 million.
This values the bond floor at 91%, with theoretical value at 103% and implied volatility at 25%. Underlying assumptions comprise a credit spread of 170bp to 175bp over Libor, historical volatility of 46%, a zero dividend yield and stock-borrow cost of 3.5%.
After opening the book for only three hours between 6.30pm and 9.30pm (HK time), observers report an oversubscription level of about six times. Prior to the completion of a formal deal analysis, bankers estimate that there were about 250 investors in total and some 20 orders above the 10% mark. Geographical splits saw about 60% placed in Europe, 25% in Asia and about 15% in the US.
Denying all reports that the deal was bought, Morgan Stanley bankers also say that the only element of the deal to be fixed pre-launch was the conversion price and this explains why the deal was launched after the close of trading on the HKSE.
Bankers also dismiss the widespread belief that the deal was placed with hedge funds, claiming that its balanced characteristics appealed to outright funds, with healthy interest from fixed income accounts and a smattering of demand from equity investors.
Most convertible experts agree that the deal provides one of the few instances of a balanced deal in the Hong Kong sector and marries the incredibly appealing attributes of a solid investment grade credit (BBB/Baa1) with a highly volatile stock
However, most also say that there is very little stock-borrow available and that while the structure offers a fantastic volatility play, extracting value from it will prove difficult. The key determinant for most players will be how far, if at all, the stock falls after it opens in Hong Kong today (Friday). Indeed, one of the most interesting dynamics of PCCW's stock price since the days when it traded at HK$18 per share, has been the way it has been continually shorted down, with no sign of arbitrageurs ever looking to cover their positions.
Because of the lack of borrow, some convertible experts comment that hedge funds may take a short-term view to buy the deal as a normal long position and wait for borrow conditions to ease before putting shorts in place. "No matter what anyone might say, up to 80% of this deal will end up in the hands of hedge funds within a month," one banker argues.
Others believe that there is likely to have been a lot of switching out the two outstanding deals. "Accounts are likely to have sold the original issues using the borrow released to purchase the new deal," a second banker explains.
He adds, "The $1.1 billion PCCW convertible due December 2005 is completely out-of-the-money and trading as high yield debt with no equity sensitivity. It has a conversion premium of 258% and yield of 7.7%. The old deal is also at the holding company level, while the new one is at the operating company level, which puts it in solid investment grade land and hence is much more attractive."
But more importantly he goes on to explain that both PCCW's debut convertible of October 2000 and the Cable & Wireless exchangeable of April 2001 are trading on implied volatility levels of 40% compared to 25% for the new deal.
"The volatility of the new deal has been priced incredibly cheaply," he notes. "But it all comes down to finding the borrow. From a volatility perspective, the lack of a put option is also good because it gives investors the extra couple of years optionality."
While non-syndicate bankers concur that the deal errs on the cheap side, they also concede that this kind of pricing was inevitable for a credit like PCCW and applaud the lead for finally breaking a capital markets duck with one of its most sought-after clients.
"Much as I hate to congratulate the competition, this was a very good trade and I wish it had been ours," one banker concludes.
Within a few hours of trading the deal was bid at 100.5%. In the grey market, it had been bid up to 102% before falling a point after the deal was increased from $400 million
On PCCW's completion, Morgan Stanley launched a $175 million convertible for Siliconware Precision Industries, which is scheduled to price later today. Because of the fall in the Taiwanese equity market over the past week, indicative terms have been amended slightly from the pre-marketed levels reported in the middle of last week.
They now comprise a five-year maturity, with two-and-a-half-year call and put options and a premium redemption structure. With a zero coupon, there will also be a 10% to 15% conversion premium and a yield-to-maturity of 2.5% to 2.75%.
This compares to an original issue size of $200 million, with a 15% to 25% conversion premium and three-year put at 3.25% to 3.75%.