Korean steelmaker Posco launched its exchangeable bonds in the eye of a severe market storm on August 4, braving the elements to show that Asia’s equity-linked markets remained open for business in the toughest of conditions.
South Korean steelmaker Posco caught a small issuance window in early August to execute one of the most talked about exchangeable bonds from Asia ex-Japan year to date. It happens to be the first-ever zero coupon five-year equity-linked note in Korea, and is likely to remain the only one of its kind for the medium term at least with the worsening European credit crisis leading to a spike in risk aversion.
“The Posco deal marked a turning point for equity-linked structures in Asia,” said Nicholas Tye, head of Asia ex-Japan CB origination at Bank of America Merrill Lynch. “Up until that point, there seemed to be a resurgence of the old aggressive structures, but Posco showed that appetite was waning for deals which were not low-premium and upfront coupon-paying given the global market volatility.”
Posco’s decision to launch the EB on August 4, with a target size of up to ¥25.1bn (US$314m), surprised the market. Besides coming after days of secondary market depression, the deal was also seen as expensive.
The paper refinanced an existing exchangeable after investors exercised a put to return ¥40bn, or 75.7% of the ¥52.8bn outstanding principal. The new EBs used the underlying shares of the existing ones in a back-to-back offering and redemption. The existing EB due 2013 was puttable August 20 2011. Both convert into ADS of SK Telecom and carry an unconditional guarantee from Posco.
The marketed premium was 32%–35% over the reference price of US$15.72, with a yield to maturity of 0.5%–1.0%. The credit spread assumption at launch was 150bp over Libor, based on a CDS spread of about 130bp–140bp, but well inside the 170bp–180bp spread on Posco’s outstanding bonds.
The deal was considered expensive because there was no upfront coupon and only provided a small, back-ended yield. This meant investors had to bet on bonds that had an expected premium of about 38%–39% in such difficult markets.
Immediately, there was criticism from rival bankers and expectations were that the deal was likely to struggle and that joint bookrunners Bank of America Merrill Lynch, Barclays Capital, Citigroup, Deutsche Bank and JP Morgan would end up with a fair chunk of the transaction.
Demand, as expected, was not very strong, but investor appetite for a well-known credit like Posco – with a liquid CDS curve that could be used to hedge the credit risk – and SK Telecom’s strong financial results, ensured the book was covered. On August 4 (the day of the launch of the EB), SK Telecom said its second-quarter net profit rose 3.7% year on year to beat market expectations.
Posco priced the bonds at investor-friendly ends of marketed terms, with the conversion premium fixed at 32% and YTM set at 1% raising ¥24.526bn. The implied volatility, assuming a 3% stock skid, was 18.2%, while the bond floor was 95.2. The bonds were issued in yen – because the proceeds were to be used in that currency – and an initial exchange price of ¥1,648.20 was announced on the term sheet.
The book was not too oversubscribed, but comfortably covered – thanks to a few “chunky” orders size-wise. Geographically, the allocations were split approximately 41% into Asia, 36% into Europe and 23% into the rest of the world. The breakdown of investor types was approximately 70% hedge funds, 30% long-only investors.
The deal, however, still became a talking point because priced at par, the bonds traded at 99.00–99.50 at launch and, on August 5 (the day S&P cut the sovereign credit rating of the US), they were lower still at 98.25–98.50 with the underlying shares down 2.8%. It clearly showed that zero-coupon high-premium structures were risky in such markets. The bonds, however, had since recovered and were quoted at around 99.50–100.00 on September 20.
“Trading around the issue price, despite the challenging markets in August and September, demonstrates the bond’s defensive characteristics. It was the right type of deal to bring to this market,” said Nick Smith, head of convertibles origination, Asia Pacific at Barclays Capital.
“The order book was of high quality and dominated by the largest CB investors in the market, whereas many smaller investors were unwilling or unable to participate due to the volatile backdrop. The result on Posco was encouraging as it showed that the market was open and investors remained willing to engage around primary issuance.”
Still, the timing of the deal looked fortunate, given that the books for the deal closed half an hour before the US markets opened and then collapsed.
“The first deals to re-open the market post-summer will need to come from quality issuers offering sizes and structures that give investors confidence in after-market performances,” said Smith. “We’re in a situation where company fundamentals are taking a backseat to macro headlines. Issuers have difficulty accepting this and it will take time for either macro risk to reduce, or issuer expectations to shift.”
