YTL Power CB: turning investors on or off?

Malaysian IPP returns to the CB market for the first time since June 2001.

YTL Power priced a $250 million equity-linked deal late on Wednesday (April 27) to raise funds for overseas acquisitions. The UBS-led transaction drew a mixed response, with some bankers suggesting the lead had not only lost all its fees, but also ended up with half the offering on its books.

The deal has undoubtedly come during a difficult time for the equity-linked sector, with volatility levels remaining low, credit markets weak and CB funds crushed by losses in the US where credit spreads have blown out. At the same time, the deal still had aggressive terms even after the lead decided to price it below the level at which it had bought it.

Those close to the transaction say the order book was covered and some fees made. Their confidence in the terms is based on the fact that YTL has consistently made investors money.

Its outstanding CB due July 2006, for example, is currently bid at 133%. The company's stock price has also performed well over the past few years, with investors benefiting from M&A driven stock price appreciation and a defensive dividend yield.

Terms for the new deal comprise an issue price of 99.50%, a zero coupon and redemption price of 118.22% to yield 3.5%. The conversion premium was fixed at 15% to the stock's M$198 close on Wednesday.

There is a call option in year two with a 120% hurdle and a put option in year three at 110.56%. The settlement features of both options, however, were tweaked in YTL's favour.

YTL has the option of redeeming either option in cash or shares. Moreover, it has dispensed with the 30-day notice period investors are normally entitled to and if it decides to call the bonds after two years, it will either issue stock or cash immediately in order to mitigate share price risk.

During the book build, the only terms that were not fixed were the issue price, which was offered at 99.50% to par. Knowing it had an aggressive bought deal on its hand, UBS decided not to risk having to re-price the deal by initially offering the bonds at par.

Instead it pitched the deal at a lower level in the hope of building some momentum to the order book. It says this worked, with the deal closing one-and-a-half times covered, with participation by 40 accounts.

However, the order book is said to have been very top heavy, with two outright CB funds placing orders of $50 million each and nearly 70% of the book allocated to the top 10 accounts. About one-third of the deal was stripped.

The deal is said to have appealed to outright CB funds and fixed income funds, with virtually no interest from the classical volatility players.

This was hardly surprising given the underlying assumptions. Based on an issue price of par, the deal has a bond floor of 96.58%, implied volatility of 20% and theoretical value of par.

This is based on a credit spread of 50bp over Libor, 5% dividend yield, 5% borrow cost and 20% volatility assumption.

For CB specialists the main sticking point was the volatility assumption. As a utility, YTL will always rank as a low beta stock and in recent months has hit particularly low levels.

The company's 100-day volatility currently stands at 11.7% and its 50-day volatility at 11%.

"There's just no way investors are going to accept an implied volatility of 20% when historic volatility is more like 11%," says one rival banker. "And this is compounded by the stock settlement features. What investor is going to tolerate a put option, which lets a company deliver shares in a stock market that's not very liquid?"

"If a fund has to monetize those shares in the open market, they would almost certainly have to sell them at a discount," he adds, "Once an investor starts building a discount into their pricing models, the bond floor starts dropping away to the 92% level and implied volatility rises up to about 26%."

Terms are far more aggressive than those it was able to achieve in 2001. Then the group priced at $126 million deal with a 2.5% coupon, conversion premium of 16% and yield of 6.73%.

Underlying assumptions comprised a bond floor of 96% based on a credit spread of 180bp over Libor and implied volatility of 14%.

In defending the transaction, some bankers suggested the technical aspects of the volatility assumptions should be discounted since it is difficult to play in a market like Malaysia. Instead, they highlight that investors only paid 3.4 points for a five-year option in one of Malaysia's best companies.

Some analysts also feel the Malaysian power sector is on a credit uptick and that companies like YTL have previously been unfairly disadvantaged by state-owned electricity utility Tenaga, which has provided a ratings cap for the entire sector.

Tenaga is currently rated Baa2/BBB, but has not kept up with the A3/A- rated sovereign in recent years because it is has remained highly leveraged. Some believe this situation may now change given that Tenaga has embarked on a more aggressive de-leveraging plan and a tariff increase may finally come through this year.

Likewise, some bankers argue that YTL should be considered a high triple B credit on a stand-alone basis. In recent years its gearing has spiked thanks to its acquisition of Britain's Wessex Water and the loans it inherited.

Net debt to equity currently stands at about 180%, although pre-deal the company also had a gross cash pile of M$4 billion ($1.05 billion), which it hopes to put to work by expanding its international portfolio.

The prospect of more M&A and an increase in the 2006 gross dividend yield to 6% has helped spur the stock so far this year. It is currently up 14.96% year-to-date and is trading at about 11.5 times 2006 earnings.

Analysts also say the company will benefit from any possible re-valuation of the Malaysian dollar since this will lessen the burden of the Wessex loans.

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