SJM Holdings brings CB with zero coupon and 18-month put

SJM Holdings, the Macau casino operator, has joined the growing number of companies that are choosing to raise new capital through convertible bonds, with a HK$2 billion ($258 million) six-year offering last Thursday. The well-received deal, which was upsized from HK$1.5 billion and priced at the investor-friendly end of the indicative terms, was in the market on the same night as two Indian issuers opened the CB market in that country after 18 months with no new issuance at all.  

Equity investors seem to like the CB approach as it gives them the opportunity to be on board for further share price gains, while at the same time offering them some downside protection that is welcome in light of the significant share price rally this year already. However, the limited borrowing in many of the recent Asian deals means the CB market's former popularity with hedge funds that play the technical valuation aspects of the deals hasn't quite returned.

SJM has been listed in Hong Kong since July last year and isn't yet eligible for short-selling and the CB had all the markings of an equity play with a zero coupon and a relatively low premium that will speed up conversion. It was also offered with an unusually short put option of 1.5 years, which means investors will be able to sell the bonds back to the issuer if the share price doesn't perform in the first 18 months. The issuer can also call the bond, subject to a low trigger of just 115%, after 1.5 years to force investors to convert.

The short put may seem risky from the issuer's point of view, but a source said the put option has been structured to match the development cycle of its casinos. At present, the company is still spending some money on decking out the Grand Lisboa casino with additional VIP tables following its opening in December last year. It is also in the process of finishing the construction of its latest casino, Oceanus, which is the only large-scale mass-market casino scheduled to open next year. So, in 1-1.5 years, all of SJM's casinos will be in operation and the company will have to make the decision whether to expand its operations further by exercising the options it has to develop new land on the Cotai strip and whether to redevelop its heritage casinos.

The 1.5-year put will provide a high level of predictability with regard to the funding at the right time, the source said, noting that if the bonds aren't put back, the company will have a long period of certainty of debt funding after that. Or, alternatively, the bonds will be converted into equity, providing an even more secure source of funding.

There is of course also the possibility that 1.5 years down the road nobody will want to build anything more in Macau. "If they don't want to build anything else, there is no reason for SJM to have longer-term funding and it will be happy to pay [the bondholders] back, but if, as expected, there is double-digit growth over the next two to three years, then having equity and cash available will give the company an advantage in the market and allow it to roll out new casinos early," said the source.

The company didn't specify what it will use the proceeds for, saying only that the money will go towards capital expenditure related to developments in Macau and general corporate purposes. In a statement issued on Friday, the company also noted that the CB will strengthen its financial position.

To be sure, with a conversion premium of 20% -- fixed at the top of a 15%-20% indicative range over Thursday's closing price of HK$4.46 -- there seems to be a lot of scope for conversion. The premium translates into a conversion price of HK$5.35, which is above the all-time high of HK$4.80 that it reached last week. However, the stock is up 41% since its debut last year, and this year it has rallied 157% amid a more positive economic outlook and expectations that China will continue to ease its travelling restrictions for Macau.

The yield to put and maturity was fixed at 2% after being offered in a range between 2% and 2.5%.

Looking at the timing, SJM took advantage not just of the increased activity in the CB market, but also of the current focus on the casino industry in Macau. The deal follows a sharp rise in gaming revenues in August and coincides with Wynn Macau's $1.6 billion initial public offering that started marketing last Monday and has attracted a lot of interest so far. The company would have got a sense of the potential demand from a CB issued by Shun Tak Holdings the previous week. Shun Tak isn't a casino operator, but offers indirect exposure to the gaming-driven growth of Macau through real estate and other assets related to the tourism industry in the former Portuguese colony, including the main ferry service between Hong Kong and Macau.

Shun Tak's $1.395 billion ($180 million) offering was "significantly oversubscribed" by about 60 investors and the bonds traded up to about 102 on the first day after the sale -- despite a 6.7% slip in the share price.

SJM, which stems from the former monopoly that dominated Macau's gaming industry for decades up until the liberalisation in 2002 and is controlled by Macau's own gaming tycoon, Stanley Ho, is offering a far more direct opportunity to participate in the growth of what is already the world's largest gambling market.  

The SJM CB too traded up on the first day and late in the Hong Kong trading session Friday they were quoted at 102.2-102.4. SJM's share price fell 2.7% to HK$4.34.

The bonds attracted more than 100 investors, of which half were said to have come from Europe. The investors were said to have been quire diversified between outright investors and hedge-funds, although the fact that investors couldn't easily hedge the equity option, the hedge funds too were mostly buying on an outright basis.

The books were opened at about 5.30pm Hong Kong time and closed at 8pm -- before the two Indian deals were launched -- so as to avoid having to share the investor attention. Deutsche Bank was the sole bookrunner for the transaction.

Most investors used a credit spread between 300bp to 400bp over Hibor, the stock borrow cost was assumed at 5% and bondholders will be compensated in full for all dividend payouts. This gave a bond floor of about 95%-96% and an implied volatility of 28%.