Seeing the wood for the trees

Sino Forest launches high yield debut.

Chinese forestry company, Sino Forest, launched roadshows in Hong Kong on Friday for a $200 million to $250 million high yield deal.

Under the lead management of Morgan Stanley, the Ba2/BB- rated credit is hoping to raise seven-year funds from a 144a deal. Pricing is expected as early as Friday, following roadshows in Singapore on Monday, London Tuesday and the US for the remainder of the week.

The Canadian-listed company represents one of the most unusual credits to tap the Asian high yield market. Firstly, it operates in a sector where investors have not previously had any exposure and secondly, it has a very different shareholding structure to Asia's sprawling and often opaque family run concerns.

Sino Forest has a true institutional shareholder base. Its largest shareholder, Fidelity, holds a 15% stake. Management has the second largest stake, 7%, followed by Capital on 5.6%. About 65% of the company is in freefloat (ie investors with stakes of less than 5%) and it is hoping to secure a second listing in Hong Kong, within the next six months.

Although the company is headquartered in Hong Kong, it is currently listed in Canada where there are a number of forestry comparables. It postponed an HKSE listing via HSBC earlier this year after market conditions turned. Since then it has raised $75 million from a private placement via Morgan Stanley and proceeds, along with the bond issue, are being used to acquire new plantation assets in China.

Asian high yield deals have had a mixed reception over the past couple of years and most this year have ended up being postponed, restructured or cancelled. In this instance, however, Morgan Stanley will not simply be hoping to get the deal done. It will also be hoping investors cede the company some kind of pricing benefit for its transparent corporate structure.

Bankers have also been telling investors the covenants package further reflects the company's commitment to good corporate governance and has not been watered down. Unlike some other Asian high deals, for example, the forthcoming bond is not structurally subordinate to other debt.

While the deal is being launched at the holding company level, there are limitations of indebtedness at the operating level. These prevent debt being raised beyond a fixed charge coverage ratio (EBITDA/interest coverage) of 2.75 times in the first year, 2.85 times in the second year and 3.03 times in the third year.

In addition, there limitations on restricted payments, which state that payments cannot be made above 50% of the company's accumulated net income.

But the biggest hurdle Sino Forest needs to overcome is the pricing premium international investors normally demand for Asian high yield deals over and above their US comparables. In the global forestry sector, there are similarly rated companies from Canada and the US such as Tembec, Millar and Riverside Forest.

Tembec has a Ba3/BB- rating and a 7.75% March 2012 deal outstanding. It is currently bid at 7.57% ,or about 289bp over Treasuries.

Riverside Forest, which has a B2/B+ rating and a March 2014 bond outstanding, is currently bid at 7.42%.

Asian high yield comps trade about 100bp wider than this level and are also five-years shorter in maturity.

The most recent high yield deal and one of the closest in terms of rating is Ba2/BB+ rated LG Telecom. The Korean cellular operator raised $200 million from a five-year deal in mid July on a coupon of 8.25% and yield of 8.75%. At the end of last week, the deal was trading at 8.25%, having tightened 50bp in the space two weeks.

Other lower rated comparables include AES China, which launched the last high yield deal from China in summer 2003. The B2/B+ rated group's June 2010 deal was trading at the end of last week at roughly 8.36%.

Over the past couple of years, Sino Forest has been in de-leveraging mode, bringing down debt to capitalization from 43% in 2002 to 36% in 2003 and 27% currently. As a result of the new deal, it is likely to jump back to 45% again (pro forma).

However, as specialists point, out debt is front-loaded and as the company acquires new plantations it will generate cash fairly quickly as trees are felled. As Standard & Poor's says in its ratings release, "With yearly capital expenditure of $140 million in 2004 and 2005, free cash flow is expected to be negative. However, the company is expected to return to a positive free cash flow position in 2006."

The rating agencies also point out that Sino Forest is very well positioned within the Chinese forestry industry since the whole sector is highly fragmented and there are very few foreign companies with its level of local experience. Moody's comments that Sino Forest was one of the, "first foreign companies involved in China's forestry plantation business industry and possesses established relationships with local forestry bureaus and plantation service providers."

It adds, "Its competitive position lies in its extensive base of tree resources, knowledge and expertise in advanced plantation management practices and its reputation as an environmentally responsible grower."