Tycoons look to CBs as shares peak

The return of the convertible bond market this year suggests that Asia’s controlling shareholders see share prices approaching full value.

Asia’s controlling shareholders tend to like to sell shares at high prices, so the strong return of the convertible bond market this year could be another sign of an approaching market peak.

CB issuance in Asia ex-Japan (and excluding A-shares) during 2014 could come close to the record high of 2010 if the market follows last year’s trend of a busy final four months. Volumes are up more than 50% so far this year, with issuers in the region raising $10 billion year-to-date, according to Dealogic.

If the remainder of the year is as busy as the tail end of 2013, the CB market will surpass the $17 billion raised during 2010.

Equity-linked bankers remain optimistic that this will happen thanks to market conditions that they say are extremely conducive to issuance from Asian names.

"The overarching trend is that you had three years of very limited issuance,” said Nathan McMurtray, head of Asia equity-linked origination at Deutsche Bank in Hong Kong. “Conditions became acute at the beginning of this year and we saw issuers getting better terms than ever. There has also been a broadening of the issuer base as investors started to get more comfortable with high-yield names.”

That much was evident in January, when Biostime International, a Chinese milk powder company, made its post-IPO capital markets debut with a $322 million zero-coupon convertible bond.

While the growth of specialist long-only equity-linked investors has made it easier for investment-grade names to get deals done, the success of Biostime’s deal showed that investors are also now more willing to buy Asian high-yield names, and that has opened the door for such companies to access attractive terms in the convertible market, broadening the universe of potential issuers.

As a rule of thumb, CB specialists reckon that vanilla convertible deals in Asia are roughly half as expensive as straight debt. While it is true that converting into equity implies dilution for existing shareholders, that is somewhat offset by the premium CB investors pay.

Even so, the prevalence of big, controlling shareholders in Asia tends to mean that a 2% saving on debt costs is a secondary consideration to a high share price. However, selling equity cheap is not a concern right now. Hong Kong’s benchmark share index is up 10% this year and close to 15% during the past 12 months.

“We’ve seen a continuing ramp-up in stock prices plus increases in volatility, which has helped some companies,” said McMurtray. “Prices are at a level where management is comfortable selling equity, plus global market jitters reinforce the idea of selling at a premium before prices go in the other direction.”

CBs benefit to some extent from higher equity volatility as fluctuating prices increase the value of the embedded option, with the caveat that markets need to be stable enough to get deals done — not too hot, not too cool.

That means windows of opportunity tend to come and go, with the result that issuance is often lumpy.

This year has been no different. The busy end to 2013 carried into January as China Overseas Land & Investment raised $750 million and CP Foods brought a rare Thai deal. Together with Biostime and another CB from Haitian International, issuers raised more than $1.5 billion in January alone.

That pace did not continue during the rest of the first quarter.

“There are always gaps in the market because the CB space is so dominated by Hong Kong issuers, which are subject to two big blackouts a year,” said McMurtray.

The 60-day quiet period before Hong Kong listed companies issue their annual earnings typically creates a lull in CB issuance during February and March. There are also 30-day blackouts for one or more interim reports during the rest of the year (Hong Kong companies are only required to disclose earnings twice a year but some do so quarterly).

The tech sell-off that affected Chinese internet companies has also delayed opportunities for some issuers. However, the success of Qihoo 360’s convertible earlier this month, which was the biggest convertible deal for three years, might pave the way for a wave of tech and internet stocks to come to market, according to McMurtray.

All of this means that the looming threat of interest-rate rises is a relatively lowly consideration for companies right now. The US Federal Reserve is expected to hike rates in 2015, but investors are starting to realise that quantitative easing is much easier to get into than it is to get out of — with the result that fears of an early or aggressive tightening of monetary policy have eased considerably.

Share values will continue to be a much bigger consideration than rates during the rest of 2014, but next year is likely to bring even more issuance as the reality of higher rates draws nearer.

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