Tencent makes less-than-stellar bond debut

Chinese internet portal firm Tencent Holdings priced a $600 million maiden bond offering early Tuesday morning, making it the first internet company outside the US to sell a dollar bond. The five-year bonds priced at Treasuries plus 375bp, at the tight end of the Treasuries plus 375bp to 387.5bp guidance.

Goldman Sachs and Deutsche Bank were joint global coordinators and bookrunners. Credit Suisse and HSBC were also joint bookrunners. ANZ, Barclays Capital and Citi were co-managers.

Tencent is a debut borrower, which did not make it an obvious candidate to tap the bond markets amid rocky conditions. However, the company counts a few ex-Goldman employees among its management, including its president, Martin Lau, who joined Tencent in 2005 and was previously an executive director of Goldman Sachs's investment banking business in Asia and chief operating officer of its telecom, media and technology group; and James Mitchell, a chief strategy officer who joined the company in 2011 and was previously a managing director at Goldman Sachs in New York, leading the bank’s communications, media and entertainment research team.

Tencent was founded in November 1998 and has since grown to become China’s largest and most used internet portal. The company went public on the main board of the Hong Kong stock exchange in 2004 and has a market capitalisation of HK$283.1 billion ($36 billion). It is the largest Chinese online games company by revenue and holds a dominant position in the instant messaging and social networking space through its QQ and Qzone offerings. South Africa’s media group Naspers has a close to 35% stake in the company.

The leads started marketing the bond on Monday to take advantage of the risk-on session seen last week. This was slightly unusual given that the banks usually wait to see how US markets trade. However, given that it was late in the year and the window to tap the market was rapidly disappearing, they pulled the trigger.

Tencent’s debut bond crossed the line despite headwinds from Europe. At around 3pm New York time on Monday, just before the deal was wrapped up, ratings agency Standard & Poor’s placed 15 eurozone sovereigns on “credit watch”, indicating that there is at least a 50:50 chance that it will lower the ratings on those sovereigns.

The final deal print came at $600 million, a modest size compared to the $1 billion five and 10-year bond that investors were expecting when the company was conducting roadshows in November.

Despite strong participation from US accounts, which are more familiar with internet companies, the bonds had an inauspicious start in secondary trading on Tuesday morning. They were quoted at Treasuries plus 392bp on Tuesday morning, 17bp wide of the issue spread. Later that afternoon, they were at Treasuries plus 387bp, still more than 10bp wide.

“The bonds widened even though the US came in for 45% of the deal. The book was only two times subscribed for a downsized transaction,” said one Singapore-based fund manager. “Flippers jumped out this morning,” he added.

The deal gathered an order book of $1.3 billion from 128 accounts. US investors participated strongly in the deal and were allocated 45%, Asian accounts 45% and European accounts 10%. By investor type, fund managers/hedge funds were allocated 65%, banks 21%, retail/others 8% and insurers and central banks 6%.

As the first Chinese internet company to tap the dollar bond market and one that is operating in a highly regulated sector, Tencent had to overcome a number of hurdles. The fact that China bonds such as Sino Forest have blown up in the face of investors did not help either.

As an offshore-listed company, Tencent is not able to hold operating licences directly. In line with industry practice, Tencent has established wholly foreign-owned enterprises that enter into contractual arrangements with “variable-interest entities" owned by its founders that hold the relevant operating licences.

According to a report by rating agency Moody’s, the “contractual arrangements effectively consolidate the variable interest entities to wholly foreign-owned enterprises which also hold the majority of the core assets, such as intellectual property rights, technology and software”.

Given the lack of tangible assets and the subordinated nature of the bonds, investors were more comfortable taking a five-year risk exposure to the company. Some investors were also not comfortable with the variable interest entity structure. “The company owns internet licences through variable-interest entities — what if there are regulatory changes?” asked a second investor who had met with the company. However, Tencent’s offering circular does mention that the bonds offer a change-of-control put at 101 if there is “any change in or amendment to the laws” that “results in the group ... being legally prohibited from operating substantially all of its business operations”.

In its report, Moody’s also highlighted the uncertainties on the regulatory environment but stated that “the commitment of Tencent’s management in maintaining a net cash position and keeping a majority of the operating cashflow and unrestricted cash at the offshore listed company and the wholly foreign owned enterprises offer some protection to bondholders and partially mitigates regulatory uncertainties surrounding the variable interest entity structure”.

Tencent is rated Baa1 by Moody’s and BBB+ by Standard & Poor’s. The company has a net cash position of $2.4 billion and most of its cash is onshore. It generates $2 billion in Ebitda and its debt-to-Ebitda ratio is about 0.6 times, which is low compared to a host of other Chinese state-owned companies such as Sinochem.

Given its strong cash position, it is not clear why the company wants to issue a bond, though it has stated the proceeds will be used for general corporate purposes and reports indicate that it may make acquisitions.

According to the person familiar with the deal, the company wanted to set up a benchmark in the bond market and the bond also enables it to pay down short-term debt. He further added that it is not unusual for cash-rich tech companies to issue bonds. 

“It is very usual for tech companies to issue when they have piles of cash” said the person familiar with the deal. “Every major tech company globally is loaded with cash. Microsoft did their debut deal in 2009 while sitting on $57 billion in cash. Google debuted this year with over $25 billion in cash.”

While the company’s debt levels are currently low, investors had concerns over its future leverage. “The risk of this trade was not in the issuer’s business fundamentals, which are quite strong, but with the likelihood of an acquisition and more debt issuance,” the first investor said. “It is not possible to gauge these material risks at this time. When names like China Forestry and Hidili first came to the market they had low debt levels, but we’ve just seen Hidili downgraded on concerns over high leverage.”

The coupon for the bond was fixed at 4.625% and the notes reoffered at 99.74 to yield 4.684%. There is a make-whole call and a change-of-control put at 101 if a party aside from Naspers owns more than 35% of the company. This is to allay concerns about Tencent being bought by another company.

In terms of comparables, the Naspers 2017s were trading at Treasuries plus 400bp and fair value for a new five-year issue from Naspers would have been about Treasuries plus 425bp and Tencent’s bonds priced inside of that.