Small-cap Chinese real estate developer SRE Group has raised approximately $130 million from a combined sale of Hong Kong-listed shares and convertible bonds. The deal, which was completed on Monday night, is part of a broader balance sheet restructuring that also includes a buyback tender for the company's outstanding high-yield bonds and a relaxation of the covenants on those same bonds. The money raised on Monday will be used to pay for the buyback.
A restructuring was necessary since the 8.625% bonds due 2013 were restricting the company from taking advantage of the tentative pick-up in the China property market, but SRE didn't have the cash to buy back the bonds. The solution devised by Deutsche Bank, which is advising SRE on the restructuring, was to announce the buyback tender for the entire $200 million bond issue first, but make it conditional upon being able to raise the money to pay for it through the sale of new equity. Meanwhile, demand from equity investors was driven by the knowledge that the company was in the process of reducing its gearing and freeing up its balance sheet -- through a consent solicitation to get rid of the restrictive covenants -- to put it in a better position to capture the growth opportunities that are arising as the Chinese property market is starting to come back.
SRE focuses on mid- and high-end residential developments in Shanghai, Shenyang and Haikou. According to Moody's, it has a combined attributable land bank of 3.3 million square metres, which should be sufficient for five years worth of development.
Crucially, the company said last week that bondholders with about 78% of the outstanding principal amount had given their consent to remove the restrictive covenants, which was more than the minimum 75% needed to make this happen. The covenants were preventing further borrowing through a fixed-charge coverage ratio that the company had trouble staying above and made new equity issuance difficult since the chairman's stake wasn't allowed to fall below 40% (before this deal, the chairman controlled about 42.5%).
By June 18, the early tender deadline, investors holding a bit more than 64% of the outstanding principal had also agreed to tender at the fixed offer price of 80 cents to the dollar. Consequently, the equity and CB investors already knew that the first leg of the restructuring would be successful, barring that the company could obtain the necessary funds to pay for it.
Monday's fundraising, which account for a hefty 32% of the current market cap, was split roughly equal between the CB and the equity placement, which allowed the company to sell part of the equity at a premium. However, the conversion premium on the CB was set at a modest 10% over the reference price, which meant that the initial conversion price is actually at a small discount to the latest market price before the stock was suspended on Monday afternoon.
However, a source close to the offering noted that from the company's point of view it would have had to pay an even wider discount if it had sold that portion too as straight equity -- so it would still have been worth. Also, the aim of the restructuring is to transform SRE from a debt story to an equity story and therefore the company has no problem if the CB holders choose to convert early. However, the bonds do not have an issuer call to ensure that will happen if the share price continues to perform.
Both portions of the deal attracted healthy demand with the equity portion about three times covered and the CB about two times covered. This allowed the company to upsize both portions slightly so that it will be issuing all the 1 billion shares that it had shareholders' approval for, assuming the CB is converted in full. Most of the investors were Hong Kong- or Asia-based, with some participation from the UK and some overlap between the equity and the CB in terms of buyers.
The equity portion, which was structured as a top-up placement, initially consisted of 500 million new shares, but was upsized to 520 million, or 17.7% of the existing share capital. The shares were offered in a range between HK$0.94 and HK$1.00 and priced at HK$0.96 for a total deal size of HK$499.2 million ($64.4 million). The final price equals a discount of 10.3% versus Monday's morning session close of HK$1.07.
That discounted price was then used as the reference price for the conversion on the CB. As mentioned, the conversion premium was fixed at 10% after being indicated in a range between 10% and 20%, which resulted in a conversion price of HK$1.056. One source noted that investors were quite sensitive about the premium since the stock has already rallied about 170% since late February. SRE is also covered by only one investment bank or broker, according to Bloomberg, which means investors don't have much guidance when it comes to determining how much further upside there may be in the stock.
Also, there is little stock borrow available in market -- and none provided by the company at this point -- which means the challenge was on to convince primarily outright buyers of the merits of the deal. A low conversion premium would have made that task a lot easier. SRE's share price did fall 7.5% to HK$0.99 on Tuesday, however, which resulted in a slight widening in the effective premium to 6.7%.
The CB has a five-year maturity with a put after three years, and is denominated in renminbi, but settled in US dollars, which is the most efficient combination for companies that use renminbi as their functional currency. The renminbi denomination ensures that the company doesn't have to account for the equity option on a mark-to-market basis, while the settlement in US dollars makes the bonds more attractive to international investors.
It was marketed with a base size of Rmb410 million and an upsize option of Rmb140 million. In the end, only part of the option was exercised (to allow for an increase in the equity portion as well) for a final deal size of Rmb446.9 million ($65.4 million). The coupon (which is also the yield since the bonds have a par in-par out structure) was marketed in a range of 5%-6% and fixed at 6%.
Sources said the buyers of both the equity and the CB were fine with the fact that the money raised will go towards retiring the bulk of the company's offshore debt, especially since it is being done at a discount to par and is being replaced by cheaper equity. The total package -- the bond tender together with the consent solicitation and the combined equity/CB sale -- will therefore be earnings accretive.
Credit Suisse joined Deutsche as a bookrunner on Monday's equity and CB sale.