Tough terms force re-offer of Greentown CB

The $300 million convertible is offered at fixed terms and comes after a late spike in the company's share price.
Residential property developer Greentown China Holdings last night returned to the market with the Rmb2.31 billion ($300 million) convertible bond issue that it decided to hold off on last week, making use of the very last day before the issuance mandate from its shareholders was due to expire.

The bonds are denominated in renminbi to match the developerÆs functional currency and to avoid the mark-to-market treatment of the equity option of the CB which would have been necessary had it been issued in any other currency. The bonds will, however, be settled in US dollars so that they can be sold to international investors û a practice that is fast becoming routine among Chinese companies listed in Hong Kong.

Perhaps because of the time pressure, the deal was bought by joint bookrunners Lehman Brothers and UBS and then sold on to the market at fixed terms. Unfortunately for the banks, investors didnÆt like what they were initially presented with and the bonds had to be re-offered at 99.5% of face value.

According to sources, investors objected to the combination of the initial terms, which included a conversion premium of 41%, a 1.1% yield-to-put and a credit spread of 250 basis points. However, it is fair to say that the 41% premium over yesterdayÆs closing price raised more than a few eyebrows.

The reason was that the share price had traded at or below HK$15.32 throughout the morning session when in the final 10 minutes it suddenly jumped 40 cents to a close of HK$15.70. The stock was then suspended in the afternoon to prepare for the CB. On similar occasions it is quite common that the conversion premium is set over the volume weighted average price during the entire session û which for Greentown was HK$15.29. However, in this case the premium was set over the close, giving a conversion price of HK$22.137. Based on the VWAP, that price translates into a conversion premium of 44.8%.

Several CB specialists also questioned the credit spread, arguing that GreentownÆs outstanding high-yield bonds suggest the ôrightö level should be closer to 290 basis points over the renminbi swap curve. Investors said the bookrunners provided credit default swaps for one-third of the issue at 250bp.

The initial weak interest was likely also influenced by the vast amount of property-related paper û both convertibles and straight equity û that has flooded the market over the past month, including GreentownÆs own $297 million top-up placement that was completed on May 3. The company initially planned to do the placement and CB at the same time, but after failing to secure the terms it wanted with the banks, it decided to hold off on the latter. Had it not completed the issue before todayÆs (May 11) annual general meeting, however, it would have ended up using only half of its existing general mandate to issue up to 20% of its outstanding share capital in new shares.

The company is seeking a new mandate to issue another 20% in new shares during the coming 12 months at todayÆs AGM.

The proceeds both from the placement and the CB will be used for further land acquisitions and to fund the development of key projects that were launched in 2006.

After the bonds were re-offered, the yield-to-put increased to about 1.3%, making them slightly more appealing to investors and in the end the book was more than two times covered, sources say. More than 40 accounts were said to have participated with hedge funds and other technical buyers providing most of the momentum. But with credit protection offered for only $100 million worth of bonds, the order book also included outright buyers.

By re-offering the bonds, the bookrunners would have sacrificed 50 basis points of their fees, which initially were said to be around 70 basis points. However, late last night there was some talk that the fees had been increased to closer to 1% to partly compensate for the need to re-offer.

The zero-coupon bonds have a five year maturity, but can be put back to the issuer after three years. There is also a two-year issuer call, subject to a 120% hurdle.

Aside from the 250 basis point credit spread, the assumptions included a dividend yield protection that kicks in if the payout ratio exceeds 40% and a stock borrow cost of 3.5%, which is based on a synthetic borrow created by the bookrunners. GreentownÆs shares are otherwise not eligible for short-selling.

This gave a bond floor of 95% and an implied volatility of about 32%, which compares with a 100-day volatility of close to 44%. If one uses a credit spread of 250 basis points, the bond floor would fall to 94% and increase the cost of the equity option to six basis points, or two basis points per year.

The aggressive terms and the fact that the deal was hard underwritten makes this yet another example of how competitive the market is at the moment, with banks seemingly allowing the issuers to dictate their own terms. In the case of Greentown, sources say it was asking for a conversion premium of at least 40%.

ôThere was a lot of arm twisting and eventually it got out of hand. These terms are very aggressive,ö says one CB specialist, referring to the negotiation process with the developer that started at the time of the placement last week.

Oftentimes banks donÆt view a CB in isolation, however, which may explain why they are accepting deals that from the outside look extremely difficult to make money on, to say the least.

UBS, which acted as sole global coordinator on the CB, also helped arrange GreentownÆs initial public offering in June last year, the high-yield bond issue in November and last weekÆs placement. It is worth noting though that until now, JPMorgan has also been involved in all of GreentownÆs public fund raising exercises, including the pre-IPO CB in January 2006 of which it bought 50% for its own books. On last weekÆs placement, JPMorgan was a joint bookrunner with UBS, while the latter also acted as sole global coordinator.

According to sources, Lehman Brothers was brought in as a joint bookrunner on the CB as the company wanted two banks to run the process. Lehman bought a 5.2% stake in Greentown in mid-April, which took its total holding to 6%. It is unclear, however, whether these shares were bought as an investment or were acquired in the course of its normal day-to-day business. LehmanÆs increased interest in the company coincided with GreentownÆs Chairman, Song Weiping, assuming a short position in the stock equal to 2.6% of the share capital.

Yesterday was the first day since last ThursdayÆs placement that GreentownÆs share price traded higher, having fallen a combined 10.9% in the preceding three sessions. Even after yesterdayÆs gain it is still trading 4% below the HK$16.35 placement price, which was fixed at a 3.8% discount to the close on that day.

Like most other Mainland property stocks, Greentown has been on a strong upward trend since March 5, however, adding 48% before the placement. It is up 91% from its IPO price of HK$8.22.
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