UMC returns with negative yield CB

Taiwanese foundry company returns with its third negative yield convertible since 2009 and Asia's largest Reg S equity-linked deal in one-and-a-half years.

Taiwanese foundry operator, United Microelectronics Corp (UMC), returned to the convertible bond market on Monday with its third negative yield deal since 2009 and Asia's largest Reg S equity-linked deal in one-and-a-half years.

The transaction appears to have been well timed, with a number of research houses suggesting Taiwan will be the next recipient of foreign fund flows as investors rotate out of Asean and into North Asia.  

Lead managers Credit Suisse, HSBC and Morgan Stanley launched a $600 million zero coupon deal with an upsize option of $30 million according to a term sheet seen by FinanceAsia

Indicative terms comprised a yield-to-maturity of minus 0.25% to minus 0.75% and a conversion premium of 25% to 32.5% over the stock's NT$14 close. The five-year deal incorporates a three-year put option, which was marketed on a put price of 97.77% to 99.25% and redemption price of 96.31% to 98.76%. 

There is also a three-year call option subject to a 125% trigger, plus full dividend pass through.

Convertible bond analysts described the terms as only attractive at the bottom end of the range and unsurprisingly this is where the deal priced. The conversion premium was fixed at 25% and the yield-to-maturity at minus 0.25%, which gave the bond a put price of 99.25% and a redemption price of 98.76%. 

The upsize option was not exercised.

In the run up to pricing, the deal was being offered in the grey market at 99.75% and even those close to the transaction said it was unlikely to immediately breach par in the secondary market. "This had a pretty aggressive structure and pricing," said one participant.

Underlying assumptions for the deal comprise a bond floor of 93.1% based on a credit spread of 160bp, or 92.6% on a credit spread of 175bp. Stock borrow costs were estimated at 50bp and implied volatility at between 21.3% and 21.9%.

The order book is said to have closed around two times covered with participation from about 50 accounts. These included a mix of long only and hedge funds. 

One source close to the deal linked success to a dearth of supply. "There's plenty of money swimming around convertible funds and this is a solid investment grade credit," he said. 

"It's notable that UMC has completed the largest equity-linked deal since China Overseas Land in early 2014," he added. "It's also worth pointing out that only a semi-sovereign credit like Khazanah has been able to achieve a negative yield in Asia since the global financial crisis in 2007."

Like previous UMC equity-linked deals the offering had an FX-linked structure. This means investors pay and settle in US dollars, but UMC can carry the deal on its books in Taiwanese dollars and will not have to mark the equity option to market. 

In a research note, UBS said the structure makes the deal sligthly more cumbersome to trade and value in the secondary market. It also suggested that a tight short sell quota meant a number of investors would need to long delta the deal for a "considerable amount of time."

This was rejected by one source close to the deal, who said, "We didn't hear any complaints. Investors were able to find enough borrow."

Industry downturn

In terms of UMC's share price, the stock is down 5.1% year-to-date and an even steeper 12.5% since February 26. It is currently trading at a forward price-to-book ratio of 0.7796 times and has found it hard to breach 0.9 times since the beginning of 2012.

Every time the stock hits this level, as it did in February, it falls back again. By contrast, TSMC is trading at 3.68 times price to forward book and is up 5.3% year-to-date.

UMC recently released first quarter results, which showed foundry sales up 4% quarter-on-quarter, resulting in a gross foundry margin of 25.8%. However, the company also guided for flat wafer shipment growth and average selling prices during the second quarter.

TSMC's forecasts were even worse, with guidance suggesting a 7% to 8% contraction in second quarter revenues. This is normally a strong quarter for foundries, but Daiwa believes the outlook may turn more positive soon.

It attributes the current downturn to an inventory correction, which should only last one quarter and expects a snap-back in re-stocking demand during the third quarter.

UBS is more downbeat. It says UMC company finds itself at a crossroads as it tries to balance profitability with its technology migration. Its ramp up to 28nm, for example, has been slower than anticipated and is not expected to become profitable until 2016.  


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