In what represents the first pure fixed rate dollar benchmark from Indonesia since the financial crisis, PT Medco Energi priced a scaled down $100 million bond yesterday (Tuesday).
Issued in the name of MEI Euro Finance Ltd, the five-year issue was led by Credit Suisse First Boston and priced at 98.09% on a coupon of 10% to yield 10.5% or 585bp over Treasuries.
The transaction represents an important new marker as Indonesian credits attempt to return to the international bond markets and follows HSBC's pioneering efforts with a $125 million FRN for Bank Mandiri just before Christmas. At first sight, however, final pricing appears exceptionally wide given expectations for a yield around the 9.5% mark at the start of roadshows. It is also $50 million short of expectations.
The stellar performance of secondary benchmarks since then is also likely to compound the view. The Republic of Indonesia's $400 million 7.75% 2006 bond issue, for example, has tightened from a yield of 8.6% in mid February to 7.67% by mid-March, while PT Sampoerna's 8.375% 2006 issue has tightened from a yield of 10.1% to 9.16%. B+ rated PT Medco, stands four notches above the B3/CCC rated sovereign and two notches above B3/B- rated Sampoerna, but has priced at a roughly 286bp premium to the former and 137bp premium to the latter.
Yet what PT Medco's experience may really show is that there is a huge gap between secondary market perception and primary market reality. In recent secondary market trading, brokers have been pushing spreads to artificially tight levels on the back of almost no real liquidity. Because there has been a growing international bid for Asian credits and most investment grade names are at tight levels relative to global comparables, attention has been switching to the lower end of credit universe.
But for Medco and Mandiri before it, the reality of trying to get investors to actually part with their cash when memories of widespread defaults are still very fresh, appears to require extensive credit work, lengthy roadshows and in Medco's case very strict covenants.
As one observer puts it, "Investors obviously needed to get comfortable with the credit first, but what they really seem to be focused on are covenants. They want to make sure they ring fence any new issue to the best of their abilities."
CSFB is arguably the most deeply entrenched investment bank in Indonesia and it has used its past experiences with the APP group to offer bondholders a lot better protection with new credits coming to the market. In particular, there are three key limitations covering negative pledge, subsidiary indebtedness and maintenance covenants.
Where subsidiary indebtedness is concerned, Medco is prevented from building up any debt at any of its subsidiaries beyond an initial $15 million carve out. This has been included to prevent a situation where the holding company (APP) and subsidiary companies (Indah Kiat, Tjiwia Kimia) both gear up to unsustainable levels.
Negative pledge is defined as an agreement not to pledge any assets if doing so would result in less security for existing bondholders. Medco's issue is a senior notes offering and any new debt has to be layered on pari passu to the old and can not be secured unless the existing deal is also secured.
To avoid an APP situation where the parent was unable to service its debt because it could not upstream enough dividends from the subsidiaries, the new deal has dividend protection measures. These state that the company is prohibited from implementing any changes which inhibit its ability to upstream dividends from the operating companies.
Finally, the deal incorporates maintenance covenants rather than incurrence covenants. This means that the covenants will be reviewed every quarter similar to bank capital ratios rather than triggered by an asset sale, issuance of debt, or payment of dividends. "In previous instances," an observer explains, "a company's business might have fallen to pieces, but if it had never taken any action that invoked the covenants, they remained as they were."
Medco's covenants include a maximum debt to equity ratio of 1.75 times, a minimum assets to liability ratio of 1.5 times and an EBITDA to debt service (including principal and interest) ratio of equal or greater than one times.
The second key issue with PT Medco's deal is its distribution pattern. Where Mandiri led the way by securing strong domestic interest, Medco has relied on international accounts and as such its deal presents a truer picture of where global investors really view the country's credit.
Partly this results from different risk weightings. Because Mandiri has a 20% risk weighting, domestic banks were keen players and 60% of the deal was placed in Indonesia itself and 79% of the overall deal with bank investors. Medco, on the other hand, has a 100% risk weighting and local banks would have been a lot less keen to hold bonds on their books.
Consequently, Medco has a distribution split whereby 60% has been sold offshore and 40% onshore. In total, there were said to be 18 investors, of which 94% came from Asia and 6% Europe. By investor type, funds predominated on 49%, followed by banks 45%, insurance companies 5% and private banking 1%.
As IndonesiaÆs third largest oil company and a pure dollar earner, Medco is the ideal candidate to set a new corporate benchmark for the country. In absolute yield terms, the company has scored a success compared to where it would have been able to finance itself in the domestic market. Because of low Treasury rates, pricing also holds up to where Indonesian credits would have been able to lock in pricing even pre-crisis.
Observers also conclude that the company made it very clear during roadshows that it has learnt from past mistakes and is conscious of keeping its maturity profile long. In its rating analysis, Standard & Poor's also highlighted the strategic importance of PTTE&P's stake in the company and its clean balance sheet.
At the end of 2001, the company was in a net cash position, with a debt to capitalization ratio of 28%. And even as the company funds an $800 million capex plan, the agency concludes that gearing is unlikely to top the 40% to 45% mark.