Capital Markets

A Better Field of Play

CFO Asia's fourth annual Deals of the Year.
Cesar Bacani and Abe De RamosDecember 29, 2003

SARS. War in Iraq. Global economic slowdown. Clearly, 2003 never promised to be a great year in Asian corporate finance. The first half of the year turned out to be as barren of deals as the Hong Kong subway system was bereft of passengers during the SARS scare. But in the doldrums, the region’s CFOs were regrouping. By the end of summer a strong stream of transactions barely kept up with pent-up investor demand. Bankers are now optimistic that the window that rose for lucrative deal-making in September will remain open for some time.

Counter-intuitively, Asia’s markets and its companies look far more competitive at year-end than they did before the global gyrations of 2003 held center stage. Asian growth projections feature in the headlines every day. China’s economy has held stable amid volatile global economic conditions. India is now a darling of global equity investors. Even Japan seems to be showing stubborn signs of life. In 2003, Asia became more than a passive party to globalization, but a leader in global best practices. We selected the deals below as evidence that the region’s CFOs — and the bankers that supported them — are every bit as much players in this phenomenon as the politicians and regulators that typically grab the headlines.

Long may the good times roll.

Mergers and Acquisitions

Tsingtao Brewery’s alliance with Anheuser-Busch

Financial advisors: HSBC, Morgan Stanley

When China’s largest brewery decided it needed a strategic investor, the logical partner was America’s Anheuser-Busch. The world’s largest beermaker bought 4.5 percent of Tsingtao when it listed in Hong Kong in 1993. Nevertheless, Tsingtao had its financial advisor, HSBC, invite bids. Advised by Morgan Stanley, Anheuser-Busch came up on top, but the message had been sent. Should the preferred suitor balk at Tsingtao’s requirements, there were any number of world-class rivals waiting in the wings.

The deal set a precedent for foreigners wanting a strategic stake in China’s leading companies. One key issue was control. “Tsingtao is a hundred-year-old brand and a treasured state asset,” says Herbert Hui of HSBC’s corporate finance team. “[As] the issuer, you want to maintain control while giving the strategic investor enough economic incentive to come in and add value.” The crux of the deal was the yawning gap between Tsingtao’s China-only A-shares and the free-for-all H-shares. When talks started in May last year, H-shares were trading around HK$2.25; A-shares, the equivalent of HK$8.50.

In the end, Anheuser agreed to pay HK$4.68 apiece for 194 million shares, a 31 percent premium over the H-share price, and HK$4.45 for 114.2 million more. It also agreed to limit its voting rights to 20 percent, even if it accumulates up to 27 percent of Tsingtao. When the deal is completed in seven years, Anheuser will have two board seats and exposure to the world’s biggest and fastest growing beer market. Tsingtao will have raised US$181.6 million and gained access to Anheuser’s technical, marketing and corporate-governance expertise.

To give the market time to absorb the new issue, which would result in dilution, the deal was tailored as a mandatory convertible bond with a seven-year maturity. Anheuser was given three months to convert the bonds to 60 million H-shares, but has until 2010 to convert 248.2 million more shares. Tsingtao agreed to pay 2 percent interest on the bonds. Anheuser will return the money after conversion.

The lower price for the latter tranche was Tsingtao’s trade-off for Anheuser agreeing to dilute its voting rights. Anheuser will enjoy all economic rights to its 27 percent stake, but the Qingdao government will vote 7 percent of the shares. For Anheuser, it made little difference, as the government will still control 30.6 percent post-conversion. The trust agreement was done in Hong Kong, where H-shares trade, as the contract would have been a nightmare to execute in the mainland, where commercial laws are less transparent. Something for foreign firms with similar intentions to ponder.

Shinhan’s acquisition of Chohung Bank

Financial advisors: JPMorgan, Morgan Stanley

You know you’re in Korea when you have to walk past rows of labor protesters and shield-wielding policemen to execute a corporate takeover. Such was the experience of Shinhan Bank and its advisor JPMorgan when Shinhan acquired Chohung Bank, which as the nation’s oldest bank carried a lot of sentimental value. In fact, the resistance was so great that it’s hard to think as coincidence the mysterious disappearance of crucial loan files during Shinhan’s due diligence.

The move was complicated by the government’s populist stance. KDIC, the state-owned agency that owned 80 percent of Chohung, announced its intention to sell its entire stake during the run-up to the presidential election last year. It commanded a price of 6,200 won per share, or 50 percent above Chohung’s share price then, and 1.8 times the book value. It was much greater than Shinhan’s initial valuation of 5,500 won apiece. “The government kept throwing out very high valuations in the public arena, which created a big problem because it was much less than these nominal values,” says Helge Weiner-Trapness, managing director at JPMorgan.

Shinhan played its card by pointing to the missing loan files and the reticence of labor and management that made it difficult to obtain accurate information about Chohung. Shinhan, to be sure, would not pay the stated price without a good grasp of Chohung’s assets. The result was a unique pricing structure that satisfied both buyer and seller. Shinhan agreed to pay 6,200 won; however 1,200 of that amount was payable only depending on the performance of some of Chohung’s assets in question. Part of the payment was also in redeemable preferred shares that were set below market rates.

Effectively, the economic value of Chohung went down to 4,600 won per share. “At the end of the day, the government didn’t lose face and was able to say they got 6,200 won for the transaction, even if it was just the nominal value,” says Weiner-Trapness. The contingent payment is a unique structure in government privatizations in Asia. A normal practice in the past was an asset quality guarantee where the government would absorb the assets back if they turned out to be a dud. The contingent structure provided comfort to both parties. “Shinhan can very appropriately say, ‘If those assets turn out good, terrific, because we’re basically buying them at book value. But there are no guarantees that those assets are real, so we have not included that in the purchase price,’” says Weiner-Trapness.

The Chohung employees also win. The deal will not be concluded until three years from now — although system integration would have been completed way before — and even then, there will be little overlap between the two banks. Chohung’s strength in large corporate accounts complements Shinhan’s strength in small and medium enterprises, and together they make the second-largest bank in Korea, providing the first real threat to Kookmin Bank.

NOL’s sale of oil tanker business to MISC

Financial advisors: JPMorgan, Citigroup

There was a smile of victory behind the mask Lim How Teck wore during negotiations for an asset sale at the height of SARS. It was a smile that almost never was. The CFO of Singapore’s Neptune Orient Lines, a state-controlled container shipping and logistics company, needed to sell an asset to offload some of its debt, which stood at US$2.8 billion as of end-2002. Texas-based American Eagle Tankers (AET), which ships oil from the Gulf to the United States, was a cash-flow positive asset, but was outside of its expertise. By October 2002, NOL was sure it could sell AET.

Advised by JPMorgan, NOL invited bids, and a number of Asian, North American and European contenders turned up. But as months went on, most pulled out as some found other strategic assets to acquire, while others realized they would face financial constraints if they won the bid. By early 2003, the war in Iraq loomed and SARS later turned Singapore into a ghost town. Only one buyer was left standing: Malaysia International Shipping Corp. (MISC).

The adverse environment could have made it impossible to sell AET, much less at a premium. Thankfully, oil tanker rates were going up, and AET redrew its forecasts upwards of 30 percent. Then came a contract to ship oil from Venezuela to the east, which meant the tankers would earn revenues sailing in both directions. “We separately carved that asset out and [created] considerable anxiety that it might not be part of the aggregate pool unless they bid aggressively,” says Todd Marin of JPMorgan. That sent the message: although only one bidder was left, NOL had an asset attractive enough to sell to others.

MISC acted fast. Advised by Citigroup, the company enlisted the services of the bank from M&A advisory, credit rating defense, syndicated bridge financing, and support for subsequent long-term funding. Citigroup put together US$830 million in funds at a tight price in three days. MISC paid NOL US$445 million for 100 percent of AET, plus US$75 million in dividends that AET declared last December. MISC also assumed AET’s debt, bringing the deal size to about US$1.1 billion.

For MISC, which is focused on Asian and European routes, AET gave it access to the U.S. market that it has always craved. Going forward, MISC “has pretty much everything open for them” in terms of long-term funding, says Mohsin Nathani, managing director at Citigroup.

He adds, “MISC has not been a big borrower in the loan market — and its parent (Petronas) was rated higher than the sovereign, so the banks have a good appetite for MISC.” As deals go, both buyer and seller were happily afloat.


PICC Property and Casualty’s IPO

Financial Advisors: Morgan Stanley, China International Capital Corp.

China’s largest non-life insurer badly needed fresh capital and technical expertise. The problem: it was a state-owned enterprise with opaque and confusing finances and a mix of commercial businesses and non-paying government accounts. The solution: carve out the profitable parts and inject them into a new company to be listed in Hong Kong, and attract a strategic investor that would introduce international operating standards.

Talk about a tall order. People’s Insurance Company of China engaged Morgan Stanley and China International Capital Corp. (CICC) to get the deal done. The process started in 2001 and culminated in July 2003 when PICC Property and Casualty (PICC) was formed as a joint stock company with limited liability. The old state firm was restructured into two entities, PICC Holding, PICC’s parent, and PICC Asset Management, which absorbed some of the dubious investment portfolio.

For PICC, the journey was grueling but instructive. For a start, it had to revalue its assets according to international standards, and upgrade its actuarial analysis and auditing. It also had to meet stricter solvency margin regulations that China issued in March. While obtaining a temporary waiver from the new rules, Morgan Stanley arranged 11 billion renminbi in loans and credit facility to enhance liquidity. It also brokered an investment deal with the global insurer AIG, which bought 10 percent of PICC. To promote good governance, PICC named Standard Chartered Bank’s Hong Kong CEO Peter Wong as an independent director.

Hong Kong’s hungry retail investors needed little convincing, but institutional investors were a different breed. In a meeting with 279 of them, PICC CEO Wang Yi and CFO Wang Yincheng emphasized that while China’s growth seems unstoppable, they are keeping a conservative risk profile, improving claims management and underwriting, and rationalizing the investment portfolio. The result: US$20.6 billion worth of orders. When the H-shares were floated in Hong Kong in October, the institutional tranche was 50 times oversubscribed, the retail tranche, 130 times. The IPO raised US$696 million and an additional US$250 million from AIG.

The mad scramble begs the question: did Morgan Stanley and CICC misprice the issue? Balancing fundamentals and hype is always tricky. The bankers had responded by upgrading the price range from HK$1.30-1.70 to HK$1.60-1.80. Retail investors might have snapped up the offer at a richer valuation — the stock was trading at HK$2.575 on November 14, up 43 percent from the IPO price of HK$1.80 — but it’s unclear whether institutions would have done the same. Nonetheless, PICC is elated. The offering raised more money than expected, it won credibility as it partnered with AIG and improved internal processes, and it blazed the trail for other insurers.

Chunghwa Telecom’s American Depositary Receipt issue

Financial advisors: Goldman Sachs, Merrill Lynch, UBS

It takes a lot of character to fight the system. Every year, Lu Shyue-ching, president of Chunghwa Telecom, faces Taiwanese legislators overseeing the former fixed-line monopoly. It’s often a painful process. Last year, they questioned an equipment purchase, threatened its US$1.1 billion budget, and demanded an overhaul in its billing system. Lu, who also acts as CFO, needed plenty of nerve to persuade them to back off.

Fortunately for Chunghwa and other government-owned companies, Taiwan is keen on privatization. Chunghwa had already floated 16 percent of its shares in a local IPO in 2000. The company planned to sell ADRs in New York later that year, but it didn’t happen until July this year. In the end, it pulled in a sizeable US$1.58 billion. While the government still owns 64.9 percent of Chunghwa, it is now progressively handing control to the private sector.

The ADR process wasn’t easy. The IPO came amidst the technology craze; local investors snapped it up at NT$104 per share. But the bubble was near bursting when Chunghwa registered the ADR, so potential investors expected a much-lower price. Lu knew it would have been political suicide for a state jewel, and legislators would be displeased. The opportune moment came in 2003 when the share price, adjusted for dividends, settled around NT$50 amid market uncertainties.

Chunghwa’s new chairman, Tan Hochen, also provided leadership to the privatization process, says Kenneth Poon of Merrill Lynch equity capital markets. A former vice minister, Tan knew “what it took to bridge the gap between the needs of the company, the government, and the international investor base.” He was a good match for Lu, who Mark Machin of Goldman Sachs Asia capital markets lauds for his “extraordinary energy” in communicating Chunghwa’s story to foreign investors since 2000.

“His conviction and passion for the company is not what you expect from someone with a government-owned enterprise,” says Machin. “Chunghwa was marketed as a stable company, constantly cutting costs and regularly paying out excess cash in the form of dividends.” Chunghwa has a 90 percent dividend policy; this year, it translated to a yield of 8.1 percent over the ADR price.

Populist legislators expected a local tranche for the offering, but Lu, Tan, and the bankers convinced regulators to let Chunghwa use the foreign valuation.

The final price could have been excessive if local investors went on another frenzy. They eventually paid NT$49 per share, or an ADR price of US$14.24 (one ADR equals 10 common shares). The local offer was 1.5 times oversubscribed; the international tranche, 4.6 times.

This is all the affirmation Lu needed to convince legislators Chunghwa is in good hands — and hopefully leave it be.

Bank Mandiri’s IPO

Financial advisors: ABN AMRO Rothschild, Credit Suisse First Boston

Bank Mandiri could get no respect. Formed in 1999 from the merger of four state banks, it was derided as the by-blow of four bad banks coming together to create one big bad bank. In fact, Bank Mandiri had succeeded in cleaning up the balance sheet, improving risk management and strengthening corporate governance. “In less than two years, we had already put all the [four banks’] systems into one platform,” says CFO K Keat Lee. Its bad-loans ratio is now just below 10 percent. The challenge was to persuade investors to put money in Indonesia’s largest financial institution.

Lee knew they needed convincing. Investors have long been dismayed by the string of political turmoil in Indonesia, including the Bali bombing last year. So Lee started the IPO process early. By June 2002, Bank Mandiri and advisors ABN AMRO Rothschild and CSFB embarked on a non-deal roadshow and attended investor conferences.

It paid off. More than 70 percent of participants at the events placed an order. The offering, completed in July, was oversubscribed even when priced at 1.08 times book value. The size of the offer was increased by 45 percent during the roadshow and another 55 percent in over-allotments, handing Bank Mandiri US$327 million in fresh funds.

The deal energized Indonesia’s business sector. The first international IPO since 2000, it was a test case of the state’s acceptance by global capital markets. Lee, of course, was elated. With the new funds, the bank gained fresh impetus. “We have strong government and corporate relationships,” he says, “but we’re not providing [retail customers] with credit cards, insurance products and mutual funds. We have so many things that we want to do now.”

Timing was important. “A year ago, Bank Mandiri was unsellable [even at] book value,” says J Marshall Nicholson of CSFB’s equity capital markets. War and terrorism stalked the global economy. When the environment started to improve in 2003, Bank Mandiri stepped on the gas and won shareholder approval for the IPO in late May. Regulators required a 45-day review, which meant registration would have been effective in July — past the sell-by date of audited 2002 statements for use in the IPO documents — but Bank Mandiri and its bankers persuaded them to shorten it to 24 days. It also got the option to increase the issue size.

The morning after was especially sweet. Bank Mandiri closed 26 percent higher on its first trading day. Four months on, the stock remains a market favorite, trading at nearly 40 percent above the IPO price. Bank Mandiri has gained the respect it craved.

Fixed Income

Hong Kong’s retail-targeted minibonds

Financial Advisor: Lehman Brothers

Ford Motor Credit’s cantobonds

Financial Advisor: Standard Chartered

CFOs wondering where to put their money in this low-interest rate environment are not alone; ordinary depositors, too, have been looking for higher returns. So when Lehman Brothers introduced the first “minibonds” targeted at Hong Kong retail investors in January, it opened a new and enthusiastic funding source that local and foreign CFOs could tap.

The concept of minibonds is simple. Lehman pooled together US$50 million worth of outstanding Hutchison Whampoa bonds — which were available only to big institutional investors in lots of US$100,000 — and placed them in a special purpose vehicle, Pacific International Finance. Its credit derivatives team then chopped up the bonds into smaller lots of US$5,000 each, and partnered with Sun Hung Kai Securities, among other local houses, to market the bonds to their retail clients. With a two-year maturity and an annual interest of 4.3 percent — better than a two-year time deposit — the minibonds proved a hit, prompting Lehman to upsize the issue to US$80.5 million. The bank has since done close to US$300 million of minibonds.

The deal is an investment-bank product, but its importance is something CFOs should not ignore. The success of the minibonds proved that — inasmuch as depositors could look at the bonds as an alternative to bank deposits — CFOs could tap the retail bond market as a viable alternative to bank loans.

The market is clearly nascent, but it is large; Lehman estimates at least US$400 billion in retail deposits are languishing in Hong Kong banks. Indeed, the deal paved the way for Ford Motor Credit’s cantobonds — a combined Hong Kong and US-dollar bond issue sold to retail investors last September, which was later followed by Li Ka Shing’s Cheung Kong Holdings. For more about cantobonds, read “Canto Bond Pops” in CFO Asia’s November 2003 issue.

SP PowerAssets’ bond issue

Financial advisor: Morgan Stanley

The US$2.2 billion bond issue of SP PowerAssets marks a milestone for Singapore Inc. As one of the flagship holdings of Temasek, the investment arm of the Singaporean government, Singapore Power had grown too big for its own good. Over the years, it invested in numerous businesses at home and abroad, becoming not just a power generation and distribution operator, but also a holding company with wide interests, from venture capital to telecommunications. The result is a corporate structure that is both complex and lacking in transparency. This didn’t bode well for the government’s plan to eventually privatize its energy sector, and Temasek’s intentions to monetize its investments.

With this in mind, Singapore Power decided to become a simple holding company. Over the course of a year, it transferred the domestic electricity transmission and distribution business to a newly created special purpose entity, SP PowerAssets (SPPA). (The power generation business had earlier been uploaded to Temasek.) Simple as it may sound, the restructuring involved a series of complex steps, including pushing down Singapore Power’s debt to SPPA, and the creation of a new management company that would run SPPA’s assets and manage its contracts and other licenses. Pushing down the debt at the asset level was itself an arduous task, as it had to go through Singaporean courts to obtain third-party lenders’ consent.

Now, Singapore Power is a much easier business to understand. It is a holding company — controlling, among others, SPPA, SP International, and SP Capital — with not too many people and no debt, says Sheldon Trainor, managing director at Morgan Stanley. “Instead of [continuing to raise] a bunch of money at Singapore Power [level] that they could have used to finance future acquisitions or run their business, they chose to make Singapore Power a very lean holding company.”

Where does the SPPA bond issue fit in? As Singapore Inc. moves towards privatization, it is most likely to sell its stake in the operating companies. It had to groom them in the process. As such, as part of the restructuring effort, the new utility company was given a regulatory weighted average cost of capital (WACC) to maintain. Having been injected with the transmission and distribution business, SPPA had to balance its WACC by leveraging the assets. The bond issue brought its capital structure to 75 percent debt and 25 percent equity, in line with global peers.

“In order to optimize the return on equity, they needed to leverage up the assets at an appropriate level, which was not prescribed under the regulatory regime, but is consistent with any regulated utility such as in Australia, the UK, or the US,” says Trainor.


Posco’s yen-denominated exchangeable bonds

Financial advisors: Deutsche Bank, Merrill Lynch

When Asian CFOs think about raising funds overseas, they almost always default to dollar-denominated instruments. Not Hwang Tae Hyun of Posco. The CFO of one of the world’s largest steel makers chose to blaze trails by being the first Asian company to issue Euroyen exchangeable bonds, in this case, a 2 percent stake in SK Telecom. The transaction proved there is demand to be met; the 52.88 billion yen bonds were twice oversubscribed and commanded a conversion premium of 52 percent. More importantly, Posco showed other Korean conglomerates another viable means of unwinding their cross-shareholdings.

It was an equity-linked issue done right. The success of a convertible lies in two factors: the creditworthiness of the issuer to provide comfort for the bond interest payments, and the volatility of the underlying securities to provide potential gains.

In terms of credit, Posco was a good candidate, with a single-A credit rating and a healthy, stable cash flow. In terms of volatility, the underlying securities were American depositary receipts of SK Telecom, which belongs to an inherently volatile sector. The choice of currency added to the volatility. “In yen volatility terms, SK Telecom is 1 to 2 points higher than in dollars, so by buying the security, you’re actually capturing a marginal benefit,” says Sanjay Arora of Deutsche Bank. Given these benefits, investors were willing to pay a high premium for the conversion.

Posco enjoyed multiple benefits from issuing in yen. First, it obtained a cheaper cost of funds, as seen in the negative yield-to-maturity. Arora reckons that while the conversion premium wouldn’t have been different if the issue was done in U.S. dollars, the yield-to-maturity would have been higher as U.S. interest rates are 200 to 300 basis points above Japan’s. Second, the yen provided a natural hedge to Posco’s revenues from Japan. Also, part of the proceeds from the issue went to refinancing a maturing samurai bond (a yen-denominated bond issued in Japan by a non-Japanese entity).

Much of the convertibles were sold to European investors, but bookrunners Deutsche Bank and Merrill Lynch also saw an increase in demand from Asian investors, who had typically preferred dollar-denominated, plain vanilla deals. The Posco deal opens an idea for Asian corporations to diversify their funding sources into the currencies of markets they trade with. “Companies are now beginning to think, ‘Do I want to issue in dollars because the dollar will depreciate, or do I want to do it in local currency or yen as a hedge to my underlying business?’” says Arora. It wouldn’t be surprising to find Asian issuers tapping the Australian dollar, Singapore dollar, or euro convertible markets.”

SingTech’s exchangeable bonds

Financial advisors: Citigroup, Credit Suisse First Boston

As CFO of Singapore Technologies, Ng Boon Yew is flooded by financing proposals. So when the top government-linked corporation (GLC) sought to raise cash for working capital and acquisitions, he already knew his options. Why not unlock the value of the company’s stakes in listed subsidiaries by issuing exchangeable bonds against them?

Thus was launched a potentially transformative exercise for SingTech and other GLCs. Critics deplore how the GLCs stifle competition, innovation and entrepreneurship. The deal showed that Singapore is taking a step toward divestment. For Temasek, the state investment firm, the deal was also a painless way to reap returns without immediately giving up control.

SingTech knew what it wanted: fat conversion premiums over the current stock prices, a long maturity to maximize the chances of convertibility, and the lowest fees possible. Ng also wanted to launch not one but two offerings backed by stakes in CapitaLand and ST Engineering. He invited 15 investment banks to bid to get the best price. (Too many, grumbled the bankers.) To guard against market risk, Ng wanted the deal done fast. So ten minutes after the Singapore Exchange closed at 5 pm on October 2, SingTech formally requested bought-deal terms. By 8 pm, it awarded joint books to Citigroup and CSFB. By 1 am on October 3, the banks had sold the bonds on a first-come first-served basis.

The pricing attracted premiums of 46.7 percent for CapitaLand and 45.8 percent for ST Engineering. “These premiums are extraordinary,” says Kirsty Mactaggart of Citigroup’s equity capital markets. “They got US$464 million monetized upfront and the yield was just 1.08 percent a year [for CapitaLand] and 1.56 percent [for ST Engineering].

SingTech locked in S$800 million in financing at a cost of 1 percent.” The maturity was set at seven years, with the put provision kicking in after five years. Assuming full exchange, SingTech will still end up in control of 52.5 percent of CapitaLand and 51.1 percent of ST Engineering. There was one hitch. SingTech wanted the bonds to trade as soon as the market opened to avoid disruption to the underlying shares. But documentation took a while, so the bonds got listed only in the afternoon. In the gray market, they traded up to 3 percentage points below issue price. But the bonds stabilized. New exchangeable bonds may be in the offing. Says Mactaggart: “This is an ideal structure for [GLCs] and I’m sure you’ll see more.”

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