After three weeks with no major deals, the convertible bond market in Asia sprung back to life last night with two transactions that could not have been more different from one another.
First to launch was United Microelectronics Corp with a $500 million five-put-three deal that had a zero coupon and a negative yield. The well-flagged deal was also linked to the new Taiwan dollar, but settled in US dollars. By comparison, the second deal was simplicity personified — an $800 million equivalent three-year bullet deal with no issuer call that was denominated in Hong Kong dollars and offered a small cash coupon. However, it did come with a massive 65% conversion premium that was fixed at launch. The issuer was Wharf Holdings, a Hong Kong blue-chip that is a rare issuer not just in the CB market, but in the equity market as well.
The different structures meant that the two deals targeted somewhat different investors and the fact that both of them were in the market on the same night doesn’t seem to have had any noticeable impact on the demand. By the time Wharf launched at about 5pm Hong Kong time, UMC had already been in the market for a couple of hours and since the latter closed at around 6pm there wasn’t actually that much overlap between the two deals.
The Wharf CB was initially kept open in an attempt to attract enough investors to exercise the $200 million upsize option since size was a key objective for the issuer. In the end, the deal was kept at $800 million and there were suggestions that even that may have been difficult to place in full.
Clearly a 65% premium doesn’t appeal to everyone. Set over yesterday’s close of HK$54.55, the premium gives a conversion price of HK$90 — a level that is 45% above Wharf’s record high of HK$62 that it reached in January this year and about HK$10 above Wharf’s HK$78 to HK$80 net asset value as estimated by analysts. This would be a challenge to push through since the stock tends to trade at a 10% discount to NAV.
However, the company is on a mission to expand in China and is confident that the completion of another couple of projects will significantly boost booth its NAV and share price. Even if investors may not actually believe the CB will ever be in the money, the company’s blue-chip status and 100-year history meant some players — primarily private banking investors — were happy to hold the bonds for the coupon payment alone, sort of like a fixed deposit account with equity upside in case the share price does perform according to the company’s expectations. According to one source, about 30% of the demand came from private banking accounts, which is more than would normally be expected for a CB and that did help push the deal over the line. About 50% came from hedge funds and 20% from outright investors, primarily in Europe.
While the order books were still open last night, the CB was trading slightly below par in the gray market, but early this morning bonds were said to be changing hands at par.
Wharf is a single-A rated Hong Kong-listed conglomerate, whose businesses range from property and retail to ports and telecommunications. It is the landlord for what is arguably two of Hong Kong’s most well-known malls, Times Square in Causeway Bay and Harbour City next to the quay where most cruise ships dock when visiting Hong Kong.
The deal was offered with a coupon and yield-to-maturity between 1.8% and 2.3% and was priced at the wide end. It was launched at a size of HK$6.22 billion ($800 million) with an upsize option of HK$1.56 billion. According to the term sheet, the money will be used to finance or re-finance Wharf’s property investments and developments in Hong Kong and mainland China, as well as for general corporate purposes.
The CB was marketed at a credit spread of 150bp. Goldman Sachs as the sole bookrunner offered credit default swaps at 150bp and asset swaps at an all-in 175bp. Supposedly there were enough of both to satisfy the investor demand in full, although some hedge funds said they wouldn’t bother to hedge the credit as they viewed the default risk to be very low, while others chose to only partially hedge the bonds. In all, Goldman was said to have provided CDSs or asset swaps for about 30% of the deal.
The stock borrow cost was assumed at 40bp, and the bond holders will get compensated for cash dividends above HK$1 in a single fiscal year. Together with the final terms this gave a very high bond floor of 98.5% and an implied volatility of about 25%. The latter compared to a historic volatility in the high 20s.
On the term sheet, the UMC convertible is described as being US dollar-denominated, currency-linked and US dollar-settled, which means that it is carried on UMC's books in the local currency, but will be payed for by investors and redeemed in US dollars at a fixed exchange rate. The outcome is effectively the same as if the bonds had been denominated in new Taiwan dollars and settled in US dollars.
By issuing convertible bonds linked to its local currency, semiconductor company UMC is the first Taiwanese company to catch on to a trend that has been spreading throughout Asia during the past few years. By issuing a CB that is linked to, or denominated in, their functional currency, issuers do not have to account for the equity option on a mark-to-market basis, as they would have to if they issued in straight US dollars. And by having it settle in US dollars, investors will not have to actually pay in the local currency. Any coupon payments as well as the final put or redemption amount will also be received in dollars.
Chinese companies were the first to adopt this model by issuing renminbi-denominated, US dollar-settled bonds. These bonds have proven quite popular with investors, helped by the fact that the renminbi is expected to continue to appreciate and the structure therefore offers little foreign exchange risk — rather they allow investors to make an additional gain if the Chinese currency appreciates.
Clearly that kind of one-way foreign exchange movement is a rarity, but in August last year the first Korean won-linked and US dollar-settled CB was issued by telecom firm LG U-Plus. It was followed in January by the first deal linked to the Thai baht, which was issued by BTS Group Holdings, the operator of Bangkok’s SkyTrain and bus system. Both these deals were brought to market by Morgan Stanley. The US bank was also a bookrunner on the UMC deal last night, although this time together with Nomura.
The bonds are convertible into UMC’s US-listed American depositary shares and were offered with a fixed zero coupon and a negative yield-to-put between minus 0.75% and minus 0.25%. Not surprisingly it was fixed at the investor-friendly end at minus 0.25%. The negative yield was achieved by issuing the bonds at par and redeeming them at a price slightly below par.
They also came with a conversion premium between 39% and 44% over UMC’s closing price of $2.71 in the US on Monday, which looked quite high before Wharf hit the market with its 65%. Still, it too was fixed at the most favourable end for investors, at 39%.
In addition to the put at the third anniversary, these bonds also have an issuer call after three years, subject to a 130% trigger.
This deal too was said to be offered slightly below par in the gray market, but according to a source, it was well received in the primary market and when the order books closed after three hours it was about two times covered. It was primarily bought by hedge funds who could make the most of the healthy availability of stock borrow. The high premium and negative yield also wasn’t attractive for outright investors or private wealth money.
However, the bookrunners offered no asset swaps for this deal, which they were said to justify by the fact that UMC is a strong and well-known credit that doesn’t need to be hedged. Since it is settled in US dollars, there were no asset swaps available in the market either, although it is possible that Taiwanese banks will offer this in due course.
The bonds were marketed at a credit spread of about 150bp over Libor and with a stock borrow cost of around 3.5%. Investors will get compensated for dividend payments in full. At the final terms, this models out at an implied volatility of about 22% and a bond floor around 97% to 98%.
UMC’s ADS price fell 4.4% in US trading over night, but this shouldn’t weigh too much on the CB since investors were supposedly using a 5% slide in their models.
UMC said it will use the money raised to buy machinery and other equipment.