China Yuhua Education has defied the bearish sentiment around the education sector by raising HK$940 million ($120 million) from the issue of a short-dated convertible bond on Wednesday in what is widely perceived as a pre-placed deal.
Two years after its initial public offering in Hong Kong, the Henan-based private school operator created a buzz among bond investors because it is one of the first companies from the education sector to issue a straight bond or a convertible bond offshore.
As such, there were huge discrepancies among investors when it came to determining the company’s credit in the absence of comparable stocks.
Bond traders were divided on whether the unrated issuer should be considered an investment grade or high-yield credit.
While some assume a 400 basis point credit spread on the company’s healthy financials, the number went as high as 600bp for more cautious investors who believe that regulatory uncertainties will continue to weigh on the education sector.
This was made worse by the fact that the bookrunner did not provide any credit guidance when the deal opened late Wednesday afternoon. This led to market speculation that most of the bonds were largely pre-placed to investors ahead of launch.
Uncertainties over credit assumptions did not affect the outcome of the Reg S deal, which was upsized by $18 million on top of its $102 million base deal.
The unrated issuer fixed the 363-day, Hong Kong dollar-denominated bond with a 3% coupon and an 8% premium to Yuhua’s HK$3.09 closing price on Wednesday. This translates to a HK$3.336 strike price.
Yuhua was able to fix a modest conversion premium for its new issue because it was executed concurrently with a delta placement of $27 million worth of shares, which were sold at HK$2.78 each, or a 10% discount to the stock’s Wednesday close. The conversion premium was 20% based on the placement price.
There was also a stock borrow facility of 304 million shares – equivalent to cover the entire deal – which helped draw demand from hedge funds.
Another favourable factor was the fact that Yuhua has made it clear it will use the bulk of the proceeds for acquisitions. This has fuelled expectations that the company’s revenue could increase in the long term.
In fact, Yuhua was in a solid financial position even before the convertible bond sale. It has net cash of $250 million and is generating positive operating cashflow. The company also inked a $2.1 billion credit facility with the China Citic Bank in October last year.
The biggest drawback, however, comes from the fact that Beijing is preparing to rein in mergers and acquisitions for non-profit schools, which has been the main route for listed school operators to scale up their business rapidly.
Shares in Hong Kong-listed Chinese education providers fell by an average of 40% in mid-August after the Ministry of Justice started a public consultation about whether foreign education companies should be prohibited from controlling private compulsory education providers, and whether they should be banned from acquiring non-profit private schools. Most of them have not yet recovered since then.
In an extremely rare move, Yuhua attached an excerpt about the policy risks it could face at the end of the termsheet, admitting that government decisions over the law amendments may result in material adverse impact on its operation and financial condition.
Bank of America Merrill Lynch is the sole bookrunner of the convertible bond sale.