On the day of pricing, the Chinese manufacturer of photovoltaic solar cells, modules and ingots fell 11.5% amid a sharp sell-off in the entire solar power sector, taking its total losses over the past 12 sessions to 55%. However, sources say the company needed the money to pay for an ongoing expansion project and for the acquisition of wafers and thus decided to go ahead.
And while the recent sell-off has been quite spectacular, so was the rally in December and the placement price was still 50% higher than the lows around $10 in late November. Investors have been dumping solar power stocks partly because of a drop in the oil price (which makes alternative energy stocks relatively less cost-efficient), and partly because they are trying to get out of riskier shares amid current recession fears.
The structure of the deal, which comprised $117.6 million worth of ADSs and $150 million of convertible bonds, was unusual in that the ADSs were sold with the sole purpose of being used as a hedging tool for the CB. Without those additional shares, there wouldnÆt have been enough shares in the market available for lending, which would have made the CBs a much harder sell and would likely have resulted in a less favourable pricing.
The additional shares were effectively lent by Solarfun to Morgan Stanley (the sole arranger of both the share sale and the CB) through a sale and repurchase agreement. The US investment bank then sold them on to investors through a normal bookbuilding exercise, creating a short position on its own books that was then transferred to the CB holders through a total-return swap agreement.
According to sources, it was the first time that an Asian issuer had used this type of structure to facilitate the borrowing of its stock in connection with a CB issue, but it has been done by US issuers a few times. The availability of stock borrow as a way to hedge the equity option on a CB is quite crucial in the US, where investors typically buy CBs to play the volatility. This is different to Asia where it often isnÆt possible to borrow the CB issuerÆs stock. As a result, investors either buy the CBs on an outright basis taking a view on the equity story, or hedge the credit portion of the deal through credit default swaps.
The fact that the money from the ADS sale wasnÆt going to the company would have made the management less concerned about the continued decline in the share price, although the need for Morgan Stanley to price the shares at a substantial discount to the market price in order to attract enough buyers would have put even more pressure on the stock. Indeed, SolarfunÆs share price fell another 3.9% overnight in the wake of the deal to a close of $16.15 even as the broader market staged a turnaround that saw the Nasdaq composite index gain 1.9%. To be fair, Solarfun did recover from an intraday low of $14.30 in early trading.
The ADSs sold by Morgan Stanley were priced at $15 apiece, which was equal to a 10.8% discount to WednesdayÆs closing price of $16.81. At that price, however, demand was strong enough that the seller was able to increase the number of ADSs on offer to 7.84 million plus a 15% greenshoe. The initial plan was to sell five million ADSs, or 5.75 million including the shoe.
Despite the persistent declines, sources say some investors were keen to buy the stock at this price as the outlook for the company is good and demand for the solar power is expected to continue to rise. According to independent solar energy research firm Solarbuzz, annual photovoltaic installations are expected to increase to 4.2GW by 2011 compared with a total installed photovoltaic electricity generating capacity of 7GW today. Industry revenues are projected to increase to $18.6 billion in 2011 from $10.6 billion in 2006.
ôAt $15, some investors considered the stock a steal,ö one source says.
Given the current environment, the CB portion of the deal was not surprisingly priced towards the most generous end of the indicative terms, although neither the coupon nor the conversion premium were overly cheap compared to similar offerings. The bonds have a 10-year maturity, but can be put back to the issuer after seven years. There is also an issuer call after seven years.
The coupon was fixed at the bottom of the 3% to 3.5% indicative range, while the premium was set at 27.5%, just inside the tight end of the 27% to 32.5% range.
On a volatility basis, however, the bonds do look cheap with an implied volatility of only 26%. This is well below the 100-day historic volatility of 125%. The bookrunner provided no credit bid, but sources say it would be reasonable to assume a bond floor in the 70%-80% range, which is quite normal for a US-style CB û especially considering the effective seven-year maturity.
According to the source, both the ADS and the CB was well covered with more than 30 investors participating in the equity portion and around 20 in the CB. Given the complexity with the total return swap, the bonds were offered only to a small group of about 20-30 investors. Most of the buyers were US-based, and in fact the CB was offered on a 144A only-basis, which meant only investors with onshore money in the US were able to participate. The CB has a $22.5 million greenshoe that could boost the total issue size to $172.5 million in should the demand continue in the secondary market.
There was also some overlap between the buyers of the two instruments, with some CB investors deciding to buy the equity to help facilitate the hedge. Some investors who wished to take an outright view of the stock also chose to buy both the CB and the equity.
Solarfun is currently in the process of expanding its PV cell manufacturing capacity and expected to reach an annual capacity of 360MW by the middle of this year compared with about 240MW at the end of 2007. Earlier this month, the firm also signed three contracts with a Korean conglomerate that will provided it with a pre-determined number of wafers (used as a raw material when making solar cells) over a seven-year period. The contracts are worth a combined $230 million and the volume of wafers will reach over 30MW per year by 2011. The first delivery will take place this month. The Korean firm has the option to buy back a certain percentage of the wafers in the form on modules starting from 2009.
According to a regulatory filing, the company expects to receive about $144.5 million in net proceeds from the CB issue, of which it will use about $60 million towards pre-payments for wafers and polysilicon. Another $60 million will go towards capital expenditures, while $19 million will be used to repay loans from its founding chairman Yonghua Lu.
Solarfun shipped a total of 27.3MW of PV modules in the third quarter last year, which was up from 16.4MW in the second quarter and 6.5MW in the first quarter. In the same quarter, net profit rose to Rmb59.6 million ($8 million), which represented a gain of 190% from the second quarter 2007 and 146% from the third quarter 2006.