Shanda issues convertible to finance share buyback

Investors embrace the earnings-accretive deal, allowing the CB to be upsized by 19% to $155 million.
Chinese online gaming and entertainment media company Shanda Interactive Entertainment has raised $155 million from the sale of three-year non-callable convertible bonds, which it will use for a share buyback of up to $200 million.

The CB, which was arranged by Goldman Sachs, was welcomed by investors as the combination with the buyback means the deal will be earnings accretive. This allowed it to be upsized from an initial $130 million and set it thoroughly apart from two other CBs by US companies launched on the same day, one of which had to be priced outside the indicative ranges, while the other had to be pulled altogether. Nasdaq-listed ShandaÆs share price also gained 1.9% on Tuesday while the CB was being marketed û the same day when the Nasdaq composite index lost 2.6% and the Dow Jones index fell 2.4% in a belated negative reaction to the US governmentÆs bailout of mortgage agencies Freddie Mac and Fannie Mae.

The share price did fall 1.4% to $27.53 on Wednesday, perhaps reflecting a degree of hedging activities by the bondholders.

ôA lot of the companies that are coming to the market at the moment are seeking ærescue financingÆ in the sense that they have debt coming due or they need to pay for a new factory to expand capacity,ö says a source close to the offering. ôHere the story is very simple û the company feels that the share price is undervalued and has been dragged down by the global turmoil while the fundamental business is very strong. Therefore it wants to issue a convert and use all the money to buy back its shares to improve the return to investors. This is a differentiating factor compared with most other issues,ö says the source, in an attempt to explain the strong interest from investors.

The company has enough cash on its books û at the end of June it had a net cash position of $378 million û to do a $200 million share buyback without incurring any debt. However, the source says the management wished to preserve that cash to retain the flexibility to move quickly if an acquisition opportunity comes its way. The CB has a $20 million greenshoe which could bring total proceeds to $175 million, in which case the company will need to use only $25 million from its existing resources to pay for the buybacks (assuming it decides to buy back the full $200 million).

Shanda will have no problem servicing the new debt since its business is highly cash generative. In the 12 months to June it generated close to $200 million of Ebitda. The funding cost is also relatively low as the companyÆs strong financial position and healthy earnings growth meant investors were willing to accept a tight credit spread of 500bp over Libor and a coupon of just 2% - at the wide end of the 1% to 2% range, but well below three-year Libor at about 3.5% . The par-in, par-out structure means the coupon is also equal to the yield.

The CB was launched after the close of US trading on Monday, shortly after the company announced the 12-month share buyback programme, and priced after the close of trading on Tuesday. It was offered with a conversion premium between 20% and 30% over the Tuesday close of $27.93 and priced just above the mid-point at 25.3% for a conversion price of $35 flat û a level it last traded at in early May.

Like most other stocks, ShandaÆs share price came off towards the end of last year having reached a 52-week closing high of $39.89 in late October, but staged a rebound in both February and April before taking another tumble. It has been on an upward trend since it hit a low of $22.06 in mid-July, which would have provided a positive backdrop for the CB.

There was no information on the subscription ratio, but the fact that the deal size was increased by 19% pre-shoe obviously indicates that there was a healthy take-up. Close to 50 accounts were said to have participated, consisting of all the usual US convertible investors, i.e. mostly hedge funds.

Using a credit spread of 500bp, a full dividend pass-through and a 50bp stock borrow cost (there is plenty of borrow available in the market) gave a bond floor of about 83% and an implied volatility of 31%. The latter compares with a 100-day volatility of 54%. As usual with CBs issued in the US, investors were not particularly concerned about the bond value and the credit spread was accepted without the need for a credit bid.

The CB was accompanied by a collared accelerated share repurchase transaction (ASR), which will allow Shanda to account for the bulk of its share buybacks on day one. The collared ASR will see Goldman collect the shares that are being sold short by the bondholders for hedging purposes and sell them on to the company. It will then buy shares in the market to cover its short position over a period of time, getting reimbursed by Shanda for any additional outlays within a pre-agreed band. This structure, which is common in the US, allows the company to bypass rules that limit the amount of shares that can be repurchased per day.

However, in this case Goldman will not borrow the full $200 million in the market and sell on to the company (as is often the case), but will only collect the shares that are being sold short to cover the delta on the CB û roughly about 60%-65% - leaving the company to buy back the rest in the market. The full buyback would account for about 10% of ShandaÆs current market cap of $2 billion.

GoldmanÆs relationship with Shanda dates back to 2004 when it arranged both its $153 million IPO and a $275 million zero-coupon CB, which has since expired.

Shanda is one of the top two online gaming companies in China with a current portfolio of 21 games, spanning massively multi-player online role-playing games (MMORPGs), casual games and network PC games, and a development pipeline consisting of another 18 games. It also provides a variety of cartoons, literature and music through its different online sites.
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