Strong demand for SMIC $200m convertible

Supported by an investment grade rating from S&P, the Chinese chip maker is able to achieve a zero percent coupon and yield as well as a 35% conversion premium.
Investors liked the fact that SMIC is quite a liquid stock.
Investors liked the fact that SMIC is quite a liquid stock.

Hong Kong-listed Semiconductor Manufacturing International Corp (SMIC) has raised $200 million from the sale of convertible bonds that met with massive demand from investors.

The five-put-three deal, which launched after the market closed on Thursday, drew more than 100 accounts and, according to one source, was about nine times subscribed – a big number, especially when considering that the bookrunners started to cap orders at 20% of the total issue five minutes into the bookbuilding.

The order amount confirmed once again the strong appetite for investment grade names. SMIC has obtained a BBB- rating by Standard & Poor’s ahead of this issue, which sources said made a big difference in terms of providing confidence in the quality of the credit. The CB itself isn’t rated.

The deal also received the support of two existing shareholders – Datang and an entity controlled by China Investment Corp (CIC) – which said that they intended to exercise their pre-emptive rights to keep their current shareholdings in the Chinese chip maker intact, subject to approval from independent shareholders.

If they end up doing so, SMIC will issue an additional $86.8 million worth of CBs to the two companies, which own a combined 30.3% of the outstanding share capital, increasing the total size of the CB to $286.8 million, the term sheet shows. Their commitment to SMIC would have helped to further strengthen the confidence among other potential buyers.

Investors also liked the fact that SMIC is quite a liquid stock with an average daily turnover of $6 million to $8 million in Hong Kong and another $1 million or so in New York.

The level of interest was similar to that seen for Khazanah’s S$600 million ($482 million) exchangeable bond into IHH Healthcare last week. The state-owned Malaysian investment company, which is arguably a top-level credit, attracted about $2.6 billion of demand and 110 investors.

The terms offered by SMIC were quite tight to begin with but, with investors piling in, the bookrunners were still able to fix the terms at the best-end for the issuer, making it the first Hong Kong-listed Chinese company to price with both a zero percent coupon and a zero percent yield. The conversion premium was set at 35% over Thursday’s close of HK$0.59.

These terms also resulted in an aggressive implied volatility of 30% to 33%, depending on what stock borrow cost one used, which compared with a 260-day historic volatility of 36%. The valuation, which assumes a 5% slip in the share price today when the stock is likely to come under some pressure from hedging activities, is particularly aggressive in light of the fact that there are no asset swaps, one of the sources noted.

The bond floor worked out at 90% at a stock borrow cost of 1%, and about 93% if you put 2% in the model. Sources said there were shares available to borrow at a price as low as 50bp or 100bp at the time of launch, but it was a limited number and the cost was expected to rise as more investors seek to hedge the transaction.

The demand for the CB continued in the immediate aftermarket with the bonds being indicated at 101 to 102 shortly after the deal priced at 8pm Hong Kong time. Later in the evening the price had edged up even further to 102.5 to 103, one source said.

The CB was marketed with a fixed zero percent coupon and a yield ranging from zero percent to 1%. The conversion premium was offered at between 25% and 35%. The final 35% premium is the highest on an Asian CB outside Japan since Hengan International’s $700 million Hong Kong dollar-denominated offering in May that also had a 35% premium. To find a deal with a higher premium, one has to go back to Wharf’s $800 million transaction in May 2011, which had a 65% premium.

The SMIC bonds mature on November 7, 2018, but can be put back to the issuer at par on the third anniversary. There is also in issuer call after two years, subject to a 120% hurdle.

They were marketed at a credit spread of 275bp over Libor, which is in line with where other BBB- credits are trading and bondholders will be compensated in full for all dividend payouts.

The demand was said to have come from all directions with Europe and Asia, hedge funds and outrights all well represented and the deal was fully covered after just 15 minutes. One source estimated that the demand was fairly evenly split between hedge funds and outrights, but as of last night there were no official numbers to confirm that.

The 35% premium resulted in an initial conversion premium of HK$0.7965 – a level that SMIC last traded at in May 2011. In May this year, it reached a 2013 high of HK$0.72 and while it has come off slightly since then it is still up 53% so far this year on the back of a turnaround in its business. The company suffered several years of losses before its current management team came on board in 2011.

The share price fell 8.1% on Wednesday this week after reporting third-quarter earnings after the market close the previous day. Some of that may have been due to a slightly disappointing fourth-quarter outlook, but the semiconductor sector as a whole also came under pressure after STMicroelectronics’ earnings missed analyst expectations.

SMIC’s share price gained 3.5% yesterday, recovering some of the previous day’s losses.

The company reported a net profit of $42.5 million for the third quarter, which was its sixth consecutive quarter with a positive bottom line and two-and-a-half-times higher than the $12 million achieved in the same quarter last year. A key reason, it said, was the 50.3% sequential growth in 40-nanometre wafer revenues, which was driven mainly by smartphone-related products.

The net profit was down from $75.4 million in the second quarter, however.

Revenues excluding wafer shipments from Wuhan Xinxin – a relationship that the company has discontinued in the past three months – increased by 21.7% year-on-year, but was up only 0.4% from the second quarter.

For the fourth quarter, SMIC is expecting its non-GAAP revenue growth excluding shipments from Wuhan Xinxin to range between flat and a negative 4.5% compared to the third quarter. CEO Tzu-Yin Chiu also said in the earnings announcement that the company is targeting “another full year of record high revenues in 2013” and added that it aims to outgrow the industry average again in 2014.

In its ratings advisory, S&P said that the stable outlook on the rating reflects its expectation that strong demand for low-cost mobile devices in China will help SMIC to maintain its profitability despite high capital expenditure over the next 24 months.

However, it noted that SMIC has weaker profitability and a weaker ability to develop advanced process technology than the global market leaders in the sector. Its small operating scale relative to its global peers also means it faces execution risk from expansion, the ratings agency said.

According to the term sheet, SMIC will use the proceeds from the CB to fund a capacity expansion at its eight- and 12-inch manufacturing facilities, and for general corporate purposes.

JP Morgan was the global coordinator for the CB as well as a joint bookrunner together with Deutsche Bank.

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