UMC/AU Optronics exchangeable priced

Huge demand highlights bull run in Asian equities.

UMC attempted to monetize part of its stake in TFT-LCD manufacturer AU Optronics yesterday (Tuesday) with a $212 million exchangeable via Lehman Brothers and Morgan Stanley. The new deal follows a previous $200 million exchangeable in May 2002, which has yet to be called by the issuer as the sector turned shortly after pricing and the stock plummeted.

This time round, UMC will be hoping it has timed the deal to catch a cyclical peak, while leaving enough room to make sure it actually gets converted straight after the six month call option.

Terms comprise a five-year deal with a zero coupon, negative yield structure. Pricing came in at 103%, the most aggressive end of an indicative range between 101% and 103%. Redemption is at 100% to give a negative yield-to-put of minus 1.5%.

There is a six-month call option subject to a 125% hurdle and two-year put at par. Last May, the deal had a more aggressive three-month call.

The exchange premium had been fixed prior to launch at 17% to the stock's NT$31.1 close. This is similar to last year, when the premium was set at 17.5% to an NT$50.5 close. There is no greenshoe.

Based on the 103% issue price, underlying assumptions comprise a bond floor of 94.6%, theoretical value of 105% and implied volatility of 19% to 23%. This is based on a credit spread of 110bp to 120bp over Libor, 1.6% dividend yield, zero stock borrow and 35% volatility assumption.

Although AU Optronics listed on the New York Stock Exchange last summer, there is no borrow on the stock because the company would not allow the deal to convert into its ADR as it is planning a convertible of its own next week. But observers also report that flow-back from the ADR to the local stock means that there would have been very little borrow even if it had been allowed.

Books were closed eight times oversubscribed within an hour-and-a-half of launch and individual orders capped at $20 million to prevent demand spiraling out of control. A total of 135 accounts participated, with a geographical split, which saw two-thirds of the deal placed in Europe and a third in Asia.

One interesting aspect of the transaction is that no orders were contingent on asset swap availability. As one specialist concludes, "As the market gets hotter and hotter, asset swap becomes less relevant because accounts just want to make sure they can get their hands on paper. I'm sure there's asset swapping taking place in the secondary market but it's no longer a tool to ensure paper can be distributed in the primary market."

AU Optronics is currently up 60.07% on the year and like many tech stocks has been consistently trading limit up on the Taiwan stock exchange. As such investors are likely to view the deal as an opportunistic play on the market's momentum, believing it will give them an in-the-money option within a matter of days.

Every single convertible deal this year bar one is now trading above par and the most recent deal by Powerchip has traded up to 117% within the space of only three weeks.

Analysts still believe the current rally has some way to run with AU trading on a low historic valuation of roughly 1.4 times 2003 book. At its peak, the sector topped four times book, while the company listed last May at 2.4 times.

According to industry research firm DisplaySearch, shipments of large area TFT-LCD panels are expected to hit a record high in the third quarter because of the growing popularity of LCD TV's. It said that 17" panel shipments overtook 14" for the first time in the second quarter, although 15" remains dominant with a 47% market share.

The firm also ranked AU third behind LG Philips LCD and Samsung with a 12.3% global market share.

Observers say that UMC's decision to monetize part of its stake in the company was extremely rapid, with a 12-day period between mandate and completion. On full conversion, the deal will monetize almost half of UMC's 11% stake. The company owns 455 million shares, of which 200 million back this deal and a further 200 million back the exchangeable of May 2002.

That deal is currently trading out-of-the-money on a conversion premium of 95%.