Tata Chemicals completed its debut convertible bond issue on Tuesday (January 25) raising $150 million from a deal led by Citigroup, Deutsche Bank and Merrill Lynch. Yet, like so many Asian CBs these days, the transaction ended up being re-priced below par, with the three banks losing practically all of their fees.
Tata's deal appears to mark yet another instance where a borrower pushes for overly ambitious terms fuelled by the aggressive pitches of investment banks jostling to get into each others deals. And the result is always the same - messy execution, no fees for the banks involved and a reputational hit on the part of the borrower, which has demonstrated its inability to read the market. In this instance there was also an unprecedented lack of chemistry between two of the syndicate banks and their third member.
The deal was initially mandated to Citigroup and Merrill Lynch back in November. Other banks, however, remained keen to muscle in and two are said to have still been there on the final day pitching highly aggressive terms.
Both banks are said to have been offered lead management positions just under an hour before launch. One is said to have pulled back because it did not feel the economics were favourable enough and it would not have enough time to complete any due diligence. The other, Deutsche Bank, is said to have accepted, much to the annoyance of the original two bookrunners, which believed the new terms would not work and they would end up having to re-price the deal.
Deutsche Bank says this is not the case - that it did pitch indicative terms to the borrower, but this was over a week before the deal was launched and that there had been no further discussions with company officials since then. Its participation was, therefore, driven by an invitation from Tata, which it accepted because it felt it could bring additional distributional firepower to bear and believed the terms would work if market conditions remained fair.
As such the three went out with a five-year non-puttable deal that had an indicative issue price of par, coupon of 1%, yield of 4.25% to 4.75% and conversion premium of 50% to 55%.
Within two hours of launch the order book is said to have been less than half covered, prompting the leads to re-price the deal slightly below its market clearing level in order to re-build some momentum. This worked and one hour later the order book closed two-and-a-half times covered with participation by 65 accounts.
At the new issue price of 98.5%, the leads lost all but 25bp of their 1.75% fee. Final terms comprised an issue price of 98.5%, coupon of 1%, yield of 4.82% and redemption price of 120.89%. The conversion price was fixed at 50% to the stock's Rs154.25.
Underlying assumptions comprise a bond floor of 95.01%, implied volatility of 31.5% and theoretical value of 100.5%. This is based on a credit spread of 170bp over Libor, 5% borrow cost, 3.58% dividend yield and 33% volatility assumption. There is also dividend protection above 3.75% - the level Tata has indicated it will pay in 2005.
The tipping point appears to have been the overly aggressive volatility assumption, even though it is not really possible to play it since the stock cannot be shorted. Based on the original issue price of par, the implied volatility would have come out at 38.5% even at the cheapest end of the range.
As one non syndicate banker explains, "The whole market has been waiting for global volatility levels to improve and there have been signs of this in shorter-term 30 and 50 day vol levels. However, volatility levels have been rising in the context of a bear market not a bull one and because of this investors remain extremely cautious. They would, therefore, continue to just focus on longer-term volatility levels and would never have been prepared to pay more than a one or two points above this."
At the time of pricing, Tata Chemicals' 100-day volatility stood at 28.5%.
In addition to this, the conversion premium was aggressive in the context of the overall Indian equity market, which has fallen about 7% year-to-date. However, this was partially mitigated by the comfort of the high bond floor, with investors paying one point of optionality for each year of the deal.
As a result of the re-pricing the deal eventually came good in the aftermarket and by the end of its first day's trading, was bid up to 99.50%.
Tata Chemicals has an AA+ rating in its domestic market and its parent provides a pricing benchmark for the credit. The equity story, on the other hand, was less easy for investors to decipher as the company is only covered by one domestic securities firm.
The deal is also large relative to the company's $750 market capitalization and its slim trading volume of roughly $2.5 million per day. Over the past year, its performance is said to have been fairly flat and it is currently valued on a P/E ratio of about 15 times historical earnings and 9.5 times forward earnings.
Tata Chemicals is one of India's largest manufacturers of fertilizer and soda ash.