Vedanta brings controversial CB

Commodities group may not have mined strong demand thanks to unusual conversion feature.

Indian metals and mining group Vedanta Resources raised $725 million late on Monday (January 23) from the sale of 20-year convertible bonds that received a controversial reception from the CB community. The deal, which includes a $125 million greenshoe, has an unusual conversion feature that made some investors reluctant to participate and the bonds traded down in the over-the-counter market yesterday.

The London-listed group mandated the deal to Barclays Capital, which went on to price it on a 4.6% coupon and 48% conversion premium to Monday's VWAP (Volume Weighted Average Price). This represented the cheap end of a range, which spanned 4.1% to 4.6% for the coupon and a 48% to 55% for the conversion premium.

The bonds were sold at par and will also redeem at par. Investors can also put them back to the issuer at par at the end of year seven, 12 and 16, giving a yield to put and maturity of 4.6%.

There is also an issuer call after three years, subject to a 130% hurdle.

The conversion price was fixed at GBP14.54 per share, based on a reference price of GBP9.825. The share price fell 6.64% during Monday's trading session, partly in reaction to the potential for a 10% dilution in case all the bonds are converted. The shares were unchanged late in London trading yesterday after being up 3.1% in the early morning.

Underlying assumptions comprise a bond floor of 83% and implied volatility of 26%. This is based on a credit spread of 290bp over Libor, dividend yield of 1.25% and a low stock borrow costs of 0.5%, which reflects the company's large market cap of about $4.9 billion and widely available borrow. Historical volatility stands at about 31%.

The most unusual aspect of the transaction is the fact the bonds will not convert into common shares, but into GDRs, which are not fungible with the underlying shares, have no voting rights and at this stage do not even exist.

Observers noted that this means liquidity in the GDRs could be very thin and whoever decides to convert first will have nobody else to trade with. Some investors were also worried that because they are not fungible, the GDRs may trade at a wide discount to the ordinary shares even though they have the same economic rights and the same dividends.

A banker at Barclays acknowledged that some hedge fund investors did not particpate for this reason, but claimed outright investors had no such problems and had bought into the deal. He also refuted claims that Barclays had been left with a lot of bonds on its own book, saying that, "the deal was subscribed, but not massively oversubscribed."

Barclays would not comment on the subscription rate or number of participating investors, but would say the bonds were trading at 99.625% in the over-the-counter market.

The company is said to have chosen the controversial structure partly to avoid stamp duty, (paid on trading of ordinary shares but not on GDRs) and partly to avoid dilution of voting rights for existing shareholders. Indeed, one observer noted that Vedanta has a very aggressive growth strategy, which it is keen to pursue with minimal interference from other shareholders.

Proceeds will partly be used for capital expenditure, including the Jharasaguda aluminium smelter project and partly for the refinancing of subsidiary debt. Some of the money will also go towards other general corporate purposes.

Vedanta's share price has had a good run, gaining 123% in 2005 and is up another 11.7% year-to-date despite the drop on Monday. A strong set of third quarter earnings released on Thursday being partly responsible for that.

The company posted a 115% rise in EBITDA to $601.1 billion in the first nine months of this fiscal year, which runs until March 2006. Revenues increased by 92% to $2.35 billion compared with the year earlier period. Compared with the second quarter, revenues rose 25%, while EBITDA was up 46%.

Still, some said the timing of the issue was not great given that Standard & Poor's downgraded Vedanta's long-term foreign currency credit ratings to BB from BB+ on Friday. The agency said this reflected, "a downward shift in its credit profile and financial risks" related to a recently announced $2.1 billion aluminum smelter and power plant project in India.

The move had been largely expected as the company has been on negative credit watch for several months. However, it still prompted a 5bp to 10bp widening of its credit curve.

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