Wockhardt re-opens Indian CB sector

Pharma company brings first convertible since elections.

Mid-cap pharmaceuticals company Wockhardt demonstrated the new pricing reality for Indian issuers on Friday (September 17) with a $100 million deal via JPMorgan.

The transaction represents the first issue from the subcontinent since national elections in May. In the interim period, the CB market has been completely closed following the disastrous secondary market performance of the eight deals, which had been launched one on top of the other in the three months prior to the change in government.

All bar one are trading below par and most crashed straight down to their bond floors after election results prompted a stock market correction and their expensive valuations popped.

Prospective issuers in the pipeline may, therefore, take heart from the size of Wockhardt's order book, which is believed to have closed roughly five times covered. But pricing also shows that issuers now have face a far more defensive and demanding investor base looking for a lot of comfort, particularly on the credit side.

Terms for the deal comprise an issue price of par, zero coupon, five-year maturity and redemption price of129.578% to yield 5.25%. This is towards the outer end of a marketed range between 4.75% and 5.375%.

The conversion premium was fixed at 50% to the stock's Rs324.05 close on Friday. This represents the mid-point of a 48% to 53% range. There is also a call option after three years with a 125% hurdle. There is also a $10 million greenshoe.

Underlying assumptions comprise a bond floor of 94.1%, implied volatility of 37.5% and theoretical value of 101%. This is based on a credit spread of 255bp over Libor (implied BB- rating), no stock borrow, 2.5% dividend yield and 100-day volatility of 42.5%.

The two stand-out aspects of the transaction are the high conversion premium and high yield. The company was able to achieve the former, because it was willing to compensate investors with the latter.

At 50%, the conversion premium is the second highest achieved so far this year after Tata Motor's 60% level in April on tranche A of its super aggressive $400 million convertible.

Year-to-date, Wockhardt up 35% and trading on a 2004 P/E ratio of 19.25 times earnings compared to a sector average around 26 times.

Being able to achieve such a high conversion premium can partly be attributed to the company's underlying growth trajectory. Net profit grew 43% from the first to the second quarter and the company is forecasting similar growth levels over the next couple of years thanks to an aggressive European expansion plan.

However, the yield on the CB is also the highest paid by an issuer so far this year. Tata Teleservices' deal in April held the previous record, with pricing at 4.5%. It is currently yielding 6.22%.

The secondary market trading levels of India's CB universe provide the key to Wockhardt's pricing. When Indian Hotels re-launched the market in early February, there was only one outstanding benchmark by Tata Engineering to price off. Now investors have nine benchmark deals to choose from and reference against.

Indian Hotels and Tata Engineering are currently the only two trading above par. At the other end of the scale, Tata Motors tranche A is bid at only 84.37% and yielding 5.31% compared to 3.75% at launch.

Specialists say about 50bp of the new pricing reality can be attributed to rising interests, while the remainder underlines how far the market has moved away from issuers' expectations. With Wockhardt, investors are also paying six points for the equity option. This is more or less in line with the average of the nine outstanding deals, which veer from five to 11 point differentials.

Specialists report the participation of 75 accounts in the deal, a fairly impressive number for a relatively small issue size. Because the transaction was launched after Asian trading on Friday, participation from the region is lower than normal and only accounts for 15% of the total. Europe took about 65% and offshore US the remaining 20%.

Specialists believe the deal went well because the pharmaceuticals sector is still highly sought after by foreign investors. Wockhardt has a small market cap of about $700 million and a freefloat of just 25%.

This means that until the CB, it was difficult for investors to build up a meaningful position without moving the market. It also means the CB accounts for a very hefty 300 days trading volume.

About 75% of the company is said to be held by the chairman who retains an option to sell down up to $30 million (100 days trading volume) at any time. The company has also said it hopes to secure a US listing within the next one to two years.

At the moment it is concentrating on expanding in Europe, which accounted for 37% of second quarter revenue. India represented 43% and the US the remaining10%.

Over the past year, the company has made two acquisitions in Europe and is planning to use proceeds from the new deal for a number more. As of end FY03, it had managed to remain relatively lightly geared, running a debt to EBITDA ratio of 1.3 times.

As a result of its recent purchases in the UK and Germany, operating profit at its European operations jumped 247% year-on-year to the end of June 2004. Its domestic business also continued to grow, up 16% during the first half.

Wockhardt primarily specialises in manufacturing high quality, low quality pain control drugs using off patents.

Successful completion of its deal may spur other pharma deals in the pipeline. Sun Pharmaceuticals, mandated Merrill Lynch and Morgan Stanley for a much larger $350 million deal in June. The company has a market cap of about $1.6 billion, just over twice the size of Wockhardt.

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