2004: Risk appetite builds

Risk-taking was back on the agenda in 2004 with a collection of new listings from Asia’s technology sector, including a US$200m Hong Kong IPO for a little-known Chinese company called Tencent. The bond markets also welcomed exotic new industries, allowing Toronto-listed Sino-Forest to make its debut, and Las Vegas Sands opened the first foreign-owned casino in Macau, repaying its project costs within months.

Appetite ran so hot, in fact, that Hong Kong’s first REIT listing triggered a backlash from institutional investors who all wanted to be cornerstones – one of the few times fund managers were begging for a six-month lock-up in return for a higher allocation.

IFR Asia 383 – December 4, 2004

CAO scandal puts due diligence in focus

The subject of how much due diligence is enough was back in the spotlight last week after Singapore-listed China Aviation Oil (Singapore) (CAO) announced that it had sought protection from creditors. The company, an oil procurement operation that supplies most of China’s jet fuel, had racked up US$550m in losses betting on a drop in oil prices through the derivatives market.

The losses – the biggest in Singapore since Nick Leeson brought down Barings Bank – are the result of CAO selling options and swaps on 52m barrels of oil after it began speculative trading about a year ago. According to an affidavit filed by its now suspended chief executive officer Chen Jiulin to Singapore’s High Court the company made losses of US$5.8m in the first quarter of the year, but then increased its bets in an effort to trade out of that loss.

The affidavit also makes clear that the S$196m (US$108m) placement of 15% of CAO’s stock led by Deutsche Bank for CAO’s parent on October 20 was specifically to cover the losses. It was, Chen says in his affidavit, “a bid to raise capital for margin calls”.

CAO had informed the parent – China Aviation Oil Holdings (CAOH) – of the losses on October 10, the documents state. On that date, CAO’s potential losses amounted to US$180m. None of this was disclosed to investors or to Deutsche.

But it was not just Deutsche that was working with a company already in deep trouble. In the week of October 3, SG launched a S$300m five-year loan for CAO into general syndication after being joined in senior syndication by DBS, ICBC, Mizuho and OCBC. The loan was not cancelled until the week of November 16.

All the banks involved painted themselves – not unreasonably – as simple victims of events and pointed out that they had all done due diligence. This apparently included confirming that CAO had a stop-loss mechanism in place that should have limited losses made by each of the company’s traders to US$500,000. Officially, all Deutsche’s spokesman would say was: “The transaction was done entirely in accordance with normal market practice.”

Nonetheless, some bankers also wondered whether Deutsche, in particular, might have missed warning signs that the company was heading for trouble. The first of these was the urgency with which CAOH wanted to do the placement, without waiting until its quarterly results on November 12. CAOH was also willing to offer a unusually high, double-digit discount, rejecting a proposal from ABN AMRO Rothschild for a lower discount at a later date. The shares were eventually priced with a 14% discount, cutting CAOH’s stake in CAO to 60% from 75%.

If Deutsche failed to head such warnings, it wasn’t alone. Two other banks were competing for the placement. Deutsche also made sure that investors – most, if not all, hedge funds wanting to cash in the 14% discount – signed a so-called “toxic waste” letter.

When CAO was forced to seek protection, it said in a statement that it didn’t disclose its losses earlier in order to ensure that it survived the crisis. According to the statement, the directors believed that the interests of shareholders would be better served if the company put together at least a potential rescue plan before the losses were disclosed. Whether investors who bought stock during that time would agree is another matter.

IFR Asia 384 – December 11, 2004

Institutions furious about likely Link allocations

Hong Kong’s Link Reit is heading for catastrophic success. The HK$21.3bn (US$2.75bn) transaction has been so inundated with applications from retail investors that institutions – apart from favoured “cornerstone investors” – are looking at next to nil allocation.

When the retail subscription period closed on December 9, the deal was about 130 times covered, triggering a clawback allocating “at least” 50% of the deal to the Hong Kong public.

With that fact in mind, institutions last week were complaining loudly that the bookrunners – Goldman Sachs, HSBC and UBS – have treated them badly. The Hong Kong Investment Funds Association (HKIFA), an industry body representing some of the SAR’s biggest fund managers, last week drafted a letter of complaint to Hong Kong’s Financial Services and Treasury Bureau (FSTB).

Before launching the Reit, the leads secured commitments from nine institutions to invest HK$4.44bn in the deal, or about 18.8% of the offer post-shoe. CapitaLand, the Singapore property company and Reit specialist, has also been allotted a guaranteed US$180m stake in the deal, or another 5.9% of the total.

In the context of a hot deal and an open-ended retail clawback, the selection process for inviting in these cornerstone investors has suddenly become vitally important to institutions. In its letter, the HKIFA asked the government to explain how the nine institutions were chosen.

“There is no mechanism for checking this allocation (members understand that supposedly the units will be allocated to funds dedicated to property investments), nor is there any mechanism for monitoring the cornerstone investors’ observance of the lock-up period. Many of our members are gravely concerned by the lack of transparency in the selection process and unit allocation procedure,” the letter said.

Regional pension funds and life insurance companies are particularly upset about not being invited in as cornerstone investors. Other investors that have a long history in Hong Kong, including JF Asset Management and HSBC Asset Management, are also furious. Prominent buy-side figures have accordingly questioned why institutions such as Stichting Pensioenfonds ABP and ING Clarion Real Estate Securities, which do not have a long history in Hong Kong, have been favoured over some of Hong Kong’s incumbent institutions.

The letter continues: “We believe it is vitally important to the future development of our financial services industry and Hong Kong as a leading international financial centre that the issues regarding the selection of cornerstone investors be reviewed by the government and the regulators, and a concrete set of guidelines be put in place.”

IFR Asia 385 – December 18, 2004

Asia Aluminum success leaves company and underwriter rolling in it

Asia Aluminum priced a US$450m seven-year high-yield issue last week that must go down as one of the most audacious bonds of the year.

Plenty in the market thought the offering would fall flat on its face – the company was raising more than its market cap and coupon payments work out to more than its last year’s profit. Yet the company and sole books Morgan Stanley managed to pull it off and the US investment bank was rewarded with Asia’s most generous primary bond fee of 2004.

Helping the success was a pretty impressive global roadshow where several key concerns were addressed. First, the company promised to address some governance issues by issuing regular updates. Second, a structured swap was put in place to lower coupon costs in the first 2-1/2-years before new factories come on line.

Rating agencies bought into the argument, too, assigning respectable Double B ratings at Ba3/BB (Moody’s/S&P). The China angle and the commodity play also helped drum up levels of interest not seen on many high-yield bond offerings this year. The company is listed in Hong Kong but its major plants are in China.

The leverage provided by some large Asian lead orders allowed final pricing to come at 8%. The order book included the top five money managers in the world, and a total of 120 investors bought bonds.

The bond is the best paying bond of the year with a gross fee of 225bp, meaning Morgan Stanley made US$10.125m. It is another major trophy trade for Morgan Stanley after well-paid high-yield deals for Sino Forest and Panva Gas earlier this year.

The bank may be sixth in the league tables for Asian G3 bonds but it is the leading fee earner by more than US$5m so far this year thanks to its list of high-yield bonds. Total fees for Morgan Stanley are now in excess of US$25m for 2004, the most for any bank in one year since the Asian financial crisis.

But the bank made even more on last week’s transaction thanks to an innovative swap. A seven-year structured swap was designed to lower the interest rate paid by the borrower in the first 2-1/2-years. At 8% on US$450m, the company was faced with an annual interest rate expense of US$36m, more than the US$28.5m in net sales made in the last 12 months.

Thanks to the swap, the company will face a lower interest rate bill in the first 2-1/2-years. After 2-1/2 years, the interest rate bill will increase above 8% but by then – in theory – its new business lines will be on line and it will have more cash to service the debt.