Powerchip prepares CB

The first of the Taiwanese DRAM manufacturers returns to the international capital markets with a convertible bond.

A $90 million convertible bond for Powerchip Semiconductor Corp (PSC) is likely to be launched today following the completion of pre-marketing last week. Investors say that lead manager Nomura has been canvassing them with a highly defensive structure that offers a leveraged equity play on a turnaround in DRAM prices.

The five-year deal has an annual puttable structure, but breaks new ground by being the first to incorporate compulsory special re-set clauses. Unlike previous defensive Taiwanese CB structures, which have incorporated annual re-sets subject to an 80% share price floor, PSC's deal will have no floor at all.

The structure has already been used once this year by Chunghwa Picture Tubes (CPT), which issued a $125 million convertible in mid-November with a special re-set that kicks in seven days prior to the first put option and re-sets the conversion price at the prevailing share price. However, in CPT's case, the re-set remains at company's discretion and it can simply opt to allow investors to put the bond instead.

PSC, on the other hand, will have no choice but to suffer the potential dilution should its share price fail to perform over the next 12 months. Year-to-date, the stock is down 46.3% and closed Friday at NT$12.35 per share. Having hit a year-to-date low of NT$ 10.75 in September, the stock is currently trading on a 2003 price to book valuation of 1.1 times compared to a high of 4.1 times during the last sector peak.

Yet although spot DRAM prices started to re-bound in October, many analysts remain wary that the cycle has really turned and a number of houses are still advising clients that a short-term share spike may offer an opportunity to sell into strength.

Because PSC is still posting losses, the company is also unable to offer investors a structure that offers any yield and the new deal has a zero coupon with annual puts at par and redemption at par. The conversion premium has been marketed at a 14% to 23% level.

Underlying assumptions include a bond floor of about 92% to 93%, theoretical value around the 105% to 106% level and implied volatility in the high teens. This is based on a credit spread assumption of 500bp over Libor, zero stock borrow, no dividend yield and a volatility assumption of 35%. Historic volatility stands at 70%.

PSC will be hoping that investors take a positive view of its recent alliance with Japan's Elpida (NEC and Hitachi) and Mitsubishi Electric, announced this October. Analysts have described the alliance as positive for PSC, but negative for the overall DRAM industry as the twin problems of overcapacity and too many players have not been resolved. Indeed, far from pulling out of DRAM production as many had hoped, the Japanese have started forming alliance with Taiwanese manufacturers that can offer cost efficient production in return for R&D.

Thus, PSC will offer Elpida capacity at its new 12" plant, which is now producing 10,000 wafers per month, while Elpida will help PSC migrate from 0.13 micron process technology to 0.11. The move will also diversify PSC's client base as it makes it less reliant on Mitsubishi Electric.

In terms of revenue, analysts say the alliance places Elpida/Powerchip at the number spot ahead of Infineon and behind Samsung, Micron and Hynix.