Sino-Environment is a small-cap company in the environmental protection and waste recovery solutions business. It provides services such as industrial waste gas treatment, recovery of volatile organic compounds (VOC), dust elimination, management of sulphur dioxide (SO2) and oxidised forms of nitrogen (NOx) for power plants, and industrial waste water treatment. Its key focus is on customers in China.
The Morgan Stanley-led deal was paired with an equity swap to make it easier for the buyers of the bonds to hedge the equity option, becoming the third Asian company this year to make use of such a feature. While the other two deals were significantly larger than last nightÆs trade, Sino-Environment only trades about $2.5 million worth of shares per day and has virtually no other stock borrow available so the facility would have been welcome. This is especially true since credit markets remain jittery and the bookrunner provided no credit bid.
Helping to facilitate the hedge, would typically also allow the issuer to use a slightly higher conversion premium. Indeed, Sino-Environment was able to fix the premium at the mid-point of the indicated range of 15% to 25%, while the coupon and yield were both set at the wide end. This resulted in a coupon of 4% and a yield to put of 6.5%. The conversion price can be reset downwards at 12 and 18 months if the share price is still trading below the initial level, but the reset is a bit more aggressive than usual at 20% above the share price at the time, subject to a floor of 70% û typically the conversion price is reset down to parity.
The 20% conversion premium was set over yesterdayÆs volume-weighted average price of S$1.8276, which was slightly below the S$1.85 closing price after the share price spiked in the afternoon and left the stock 3.9% higher on the day.
The bonds have a five-year maturity, but can be put back to the issuer after two years. There is also an issuer call after three years, subject to a hurdle of 130%. The coupon was offered in a range between 3% and 4%, while the yield was offered at between 5.5% and 6.5%.
Given the small deal size, the bonds were marketed to a limited number of investors and allocated to an even smaller group. A source close to the offering says the final allocations were quite large for a deal of this size. The latter may have been prompted by a desire to limit the number of equity swap agreements that had to be signed.
Sino-EnvironmentÆs share price has more than quadrupled since its initial public offering at S$0.33 two years ago and has gained more than 160% from its lows in mid-March, but the stock remains volatile û in October last year it hit a high of S$3.92 û and the fact that it operates in a sector that isnÆt that well-known among investors may have made it a difficult sell to a broader audience.
Under the swap agreement, Sino-Environment will use half the CB proceeds to buy back shares in the market that it will swap with Morgan Stanley, creating a short position on the investment bankÆs books. Morgan Stanley will then do matching swaps with the bond investors to pass on the short position.
Synthetic borrow facilities of various kinds have become a useful tool for the successful completion of Asian CBs this year as the asset swap and credit default swap markets have all but dried up. This particular structure, involving a share buyback, was also used on Country GardenÆs $500 million CB in February and on China High Speed TransmissionÆs renminbi-denominated $285 million CB in April. First featured in the context of an Asian issuer in August last year on the $200 million exchangeable into casino operator Melco PBL, the structure has an additional benefit in that a buyback of shares will typically have a positive impact on the issuerÆs share price. A key downside is that the issuer only gets access to about half the proceeds from the convertible.
It is unclear whether the inclusion of the equity swap made a difference in terms of which bank was given the mandate, but CB specialists say several banks had approached the company with regard to a potential deal. Morgan Stanley was the bookrunner and equity swap counterpart on the China High Speed CB as well, while Merrill Lynch arranged the deals for Country Garden and Melco.
Morgan Stanley guided investors to use a credit spread of 1,000bp over Sibor and thanks to the equity swap, the stock borrow cost came down to 1%. The bonds have a full dividend pass-through, although the company doesnÆt currently pay dividends and given that it is in a rapid expansion phase it is probably unlikely to do so for some time. Based on these assumptions, the bond floor is about 90%.
In early April, Sino-Environment signed an agreement with a subsidiary of JGC Corporation, a leading Japanese chemical and engineering contractor, for a technology transfer of denitrogeneation (DeNox) catalysts used in coal-fired power plants. On back of this cooperation, Sino-Environment plans to build up an annual production capacity of 6,000 cubic metres for this product at its Fuzhou plant, at a total capex outlay of about Rmb265 million ($38 million). According to analysts the company expects the new business to start in the first quarter of 2009 and to contribute revenues of Rmb300 million in 2009. One recent report notes that this could boost the revenue forecast for 2009 by as much as 27.5%.
I addition to this, a report issued by OCBC Investment Research on Monday says the company has secured close to Rmb600 million worth of contracts for desulphurisation û a process that is now required by the Chinese government at all coal-fired power plants to limit SO2 emissions. According to the same report, the management estimates that the value of potential contracts could exceed Rmb1 billion this year.