Posco exchangeable into SK Telecom draws strong demand

The $485 million yen-denominated deal is priced with a 23% exchange premium and a 0.5% yield-to-put.
South Korean steelmaker Posco last night sold Ñ52.795 billion ($485 million) of bonds exchangeable into SK Telecom, which drew solid demand due to its easy-to-hedge qualities.

The new issue will replace an outstanding yen-denominated exchangeable into the same stock that matures on August 20, with the proceeds from this deal going solely to cover the redemptions of that issue.

The deal was flagged by the company in mid-July, but the timing still took the market somewhat by surprise, coming as it did on a day when the South Korean equity market was under pressure following a largely unexpected interest rate increase by the countryÆs central bank. However, SK TelecomÆs Korea-listed shares have had a good run since they hit a 12-month low on July 18 with a 14% gain, including a net 6% increase over the past three sessions. The share price did fall 1% yesterday, in line with the 0.9% drop in the benchmark index.

The Posco bonds are exchangeable into SK TelecomÆs American depositary shares (ADS), which rose 6.6% in the two days before this deal and are up 11.6% since mid-July. The 17.6 million ADS underlying the issue represent PoscoÆs entire stake in the telecom operator.

The zero-coupon bonds have a five-year maturity, but can be put back to the issuer on the third anniversary. There is also an issuer call after three years, subject to a 120% hurdle. They were offered with a fixed exchange premium of 23% over WednesdayÆs closing price of $22.29, which sources say was what was needed for the total proceeds to cover the refinancing of the outstanding issue plus expenses. They were offered with a yield-to-put between 0% and 0.5%.

Not surprisingly, given the current poor sentiment in the convertible market and the fact that the bookrunners had only three hours to complete the transaction before the New York market opened, the yield was fixed at the top of that range at 0.5%. Unusually, the put price and the redemption price are both set at 101.51, which means the yield to maturity is only 0.3%. However, this would have had no impact on the overall pricing since CBs and exchangeables are typically valued off the put price.

Sources suggested it would probably have been possible to sell the bonds at a 0% yield, but that would have required an exchange premium of no more than 20%. On this particular deal, given that the proceeds will be used for refinancing, size was the key issue, however, and it supposedly didnÆt take too much convincing for Posco to accept the higher yield.

The four joint bookrunners û ABN AMRO, Citi, Deutsche Bank and Goldman Sachs û also played it safe by providing both a borrowing facility and credit protection for up to 40% of the deal to support their assumption of a 145bp credit spread. They may have felt that the size û excluding Champion ReitÆs $600 million CB (since the sponsor bought half the deal), this was the largest equity-linked deal by a non-US-listed Asian issuer since County GardenÆs $500 million CB in February û warranted some back-up of the credit, but as of last night no investors were said to have taken them up on their offer of $200 million worth of credit default swaps.

Part of the reason is that SK Telecom is a highly liquid name with stock borrow available in the market, making it easy for the EB investors to hedge the equity option. On top of that, Posco will also lend its 17.6 million ADS to the bookrunners from time to time to be used for stock lending purposes, making it easier for bondholders to alter their hedging strategies during the duration of the exchangeable. These additional shares will become available later this month when they are no longer needed as a security for the maturing exchangeable.

Sources say the deal was more than 1.5 times covered, which is impressive given the size. It attracted about 50 investors, of which the majority were hedge funds. A number of the buyers hold the maturing exchangeble or have done so at some point.

ôThis is a quality credit with a liquid underlying that is easy to borrow û just the kind of deal that you want to bring to a difficult market in August,ö one source says with regard to the demand.

Given the ample availability of stock borrow, the stock borrow cost was assumed at 50bp and the bonds have full dividend protection. This gave a bond floor of about 94% and an implied volatility of 17.8%. The latter is well below the 100-day historic volatility of 33% in yen terms (29% in dollar terms), but more aggressive than an outstanding SK Telecom convertible that matures in 2009 and which is trading at an implied volatility of about 15%.

The bonds were quoted around to slightly above par shortly after the pricing last night, even though SK TelecomÆs share price took a tumble in US trading. However, sources say a 5%-6% slippage in the share price was to be expected since last night was the first chance investors had to create a hedge for the exchangeable, and at least part of that would have been in the price of the bonds already. By the end of US trading, SK Telecom had fallen 6.2% to $20.91.

SK Telecom posted a 26.1% drop in net income year-on-year in the second quarter to W298 billion ($294 million) on a 3.1% increase in revenues as fierce competition in the saturated domestic market and the governmentÆs removal of a ban on handset subsidies prompted it to spend more on promotional packages and customer-retention programs such as lock-up contracts. Marketing expenses rose 24.6% on the year and 14.3% on the quarter to W876 billion.

However, analysts are still mostly positive on the Korean incumbent with 24 buy recommendations, versus seven holds and two sells. Among the reasons to buy, they say, are the companyÆs defensive qualities including a high effective dividend yield, and the forthcoming launch of bundling services and cross-selling opportunities with recently acquired Hanaro Telecom.

¬ Haymarket Media Limited. All rights reserved.
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