LIVING DANGEROUSLY
Despite the sharp improvement of Asian economies, CFOs seeking cash must take some risks if they want their company's growth to take flight.
By Abe De Ramos

For the first time since the Asian crisis ebbed, opportunities to expand are everywhere. Whether it's in cyberspace or plain old terra firma, CFOs today are faced with a fast-expanding range of choices for growing their businesses. Suddenly, standing still is not an option. With a wary eye on investors, customers and clients, CFOs are now under pressure to show that they're delivering shareholder value by taking the right risks and remaining competitive. All this means that financing these risks has become a priority.

Luckily, in the market for corporate finance, there's action out there in the sun. Bond markets are crawling back to life and companies that have swept the debt from their balance sheets have greater access to them. Bankers are more willing to offer structures that reduce risk for both investors and borrowers. Fuelled by increases in cashflow, Asian companies are returning to the M&A scene with vitality. Even leveraged buyouts have made an appearance in the form of Hong Kong's PCCW US$38 billion purchase of Cable & Wireless HKT.

But while there's more action, there's also more hype. The investment banks, stung by the collapse of the Internet-driven IPO market, have been touting the utility of high-yield debt, hoping that these high-fee transactions will help their Asian brackets bulge. Despite streams of press releases on its imminent revival, the junk market is only just crawling out of its oxygen tent. Convertibles, too, have been hallowed as the perfect instrument for right now, though a flood of deals has not emerged, and where companies have used them, it has been in very specific circumstances.

So CFOs, fortified by years of hard experience, are attacking their growth strategies with a healthy dollop of scepticism. The last time bankers arrived on their doorsteps, many made the mistake of trusting too much and gearing up too high. Today, risk is back on the agenda, but which way should the chastened CFO turn?

CFO Cesar dela Cruz of Indofood Sukses Makmur, the Indonesian maker of instant noodles, is negotiating this fine line and sometimes feels as if he's on a tightrope. While his company is one of the largest makers of instant noodles in the world, Indofood is hobbled by the troubles plaguing Indonesia, the economic basketcase of Asia. And Indofood, like its government, remains burdened with debt. The US$1.3 billion-a-year group has US$365 million in foreign-denominated debt falling due between 2001 and 2002, putting its net gearing ratio at about 200 percent.

Given that the local currency is still in dire straits and operating profits are just recovering from a slump, dela Cruz says selling some of the company's assets to meet its obligations remains an option, although he claims, "at the moment, there is no pressure for us" to do so.

On the other hand, dela Cruz sees tremendous growth in the food business in the region. Acquiring or merging with another company in a neighboring country is a logical way of building the Indofood brand - especially now that regional stockmarkets are quiet and valuations are cheap. "We're keeping our eyes open," he says. Funding it might be difficult, but not impossible; after all, the financially strong Hong Kong conglomerate First Pacific already owns 40 percent of his company. Then again, with assets and market leadership like Indofood's, dela Cruz knows the company itself is a tempting acquisition target, and this he says is not an option. "We'd rather be an acquirer, rather than an acquiree."

Indeed, dela Cruz is treading the line between danger and opportunity. But whichever path he takes, Indofood will be following a trail many companies in the region will take in the next year or so. Those who continue to restructure their balance sheets are exploring every conceivable debt reduction scheme - from discounted buybacks to debt-for-equity swaps to asset sales - while those in M&A mode are seeking ways to fund them as cheaply as possible.

Cash, For Some

The backdrop to all this is cash - lots of it - waiting to be invested. To get a glimpse of that amount, consider the volume of syndicated lending in Asia in the first six months of the year: US$94 billion, almost double the volume from a year ago, according to Thomson Financial Securities Data. But funding, these days, is a tricky game. If the crisis taught investors just one lesson, it is to be very selective in the way their money goes, and one can be sure that they no longer dangle their funds before just about anyone. "The funds are there, but what you have to remember about Asia is that a lot of people got badly burnt in the last three years, so people are very cautious about yet another major run in Asia," says Richard Orders, head of investment banking for ABN-Amro in Hong Kong.

This means that raising money these days for anything less than a blue chip name takes guts and determination. And, in some cases, a willingness to get on an airplane to talk to overseas bankers and investors. Consider the case of ASAT, the Hong Kong-based semiconductor maker. Earlier this year, the US$220 million-a-year company faced a crisis. Some US$117 million worth of debt was coming due. At the same time, sales and profits were growing well and the company was eager to expand its assembly and testing plants.

Its bankers explained that tapping the local bond or equity markets could fall flat as few Asian investors were keen on the semiconductor industry. In the thin local markets, only blue chip companies fare best. So, its bankers - Donaldson, Lufkin and Jenrette, Salomon Smith Barney and Chase - convinced the company to head for New York to secure a listing on Nasdaq, in the form of American Depositary Receipts (ADRs). This required a great deal of time and money, considering US authorities' tough disclosure requirements. But the investment was worth it. ASAT's 20 million ADRs listed at the second week of July and were fully subscribed at the company's pricing target of US$12 each. This was no mean feat given the bearish mood towards technology plays in the US. With the US$240 million raised, ASAT is now able to pay debts due this year and reduce its gearing ratio to 0.44. The balance will go to the expansion the company so badly wants to make.

The secret to ASAT's success, according to CFO Terry Scandrett, was communicating just where the future growth would come from. "The point we made to our investors was that we have a very strong customer base, and that a substantial portion of our business is in the communications sector, which is the fastest growing sector in the semiconductor industry," says Scandrett.

But you don't always have to be in a sexy business to attract the interest of Americans, as Khushroo Wadia, finance director of Bangkok-based Precious Shipping (PSL) found out this summer. After two years of talks with unsecured creditors, the US$70 million-a-year dry bulk carrier finalized a deal to restructure some US$60 million in debt in July. Key to the settlement was a US$24 million loan from US-based Fleet National Bank.

The terms of the loan were unusually friendly for a heavily indebted Thai company. PSL is paying only 150 basis points above Libor, with a five-year repayment period. The key was an agreement by PSL to mortgage some of its vessels to the bank, generating a second revenue stream for the lender. It also helped that Fleet has had experience in Asia. "They were looking for an opportunity now that there are a lot of companies in Thailand that are in a restructuring mode. They were looking for a well-run company," says Wadia. PSL scored on that count, he says, as it is among Asia's market leaders in the dry bulk sector. It also earns all its revenues in US dollars and keeps its operating costs low.

PSL had one other trick up its sleeve. Aside from mandating the US bank to arrange a loan, Wadia also mandated it to become a financial advisor to sit with PSL at the negotiating table with creditors. "Therefore, whatever [the bank] was looking at in terms of pricing [the loan], it was partially made up by way of the [advisory] fees, which we would have had to pay in any case to any other financial advisor. In the end, it turned out to be a win-win situation," Wadia says.

In addition to IPOs and straight restructuring deals, other avenues for refinancing debt are starting to sprout wings in Asia. The key to accessing these instruments is quality and transparency. "I'd say that high-quality companies in still-struggling markets represent much better opportunity for investors than struggling companies in a high-quality environment," observes Michael Berchtold, managing director and head of investment banking at Morgan Stanley Dean Witter (MSDW) in Hong Kong. As an example, Berchtold points to the US$350 million high-yield bond issue it recently lead managed for Indonesian firm Asia Pulp & Paper (APP). APP has been very active over the years in the debt markets, but earlier this year it needed more cash to help refinance some of its long-term debt. Despite a strong US dollar cashflow, the rise in world pulp prices and steady profitability, the US$3.1 billion-a-year APP still had to court investors with an attractive price. The bonds were priced at just 86.86 percent, to yield 16.75 percent. It worked. The March offer was oversubscribed, largely by investors in the US.

Happily for APP, this success was achieved despite the bond's junk rating of Caa1/CCC+ from Moody's Investors Service and Standard and Poor's, respectively. The rating was less to do with the company's fundamentals - its annual report meets US GAAP standards - and more to do with its Indonesian base of operations. "Deals in the high-yield market are very doable," says Berchtold. "For the right business plan, investors are very much prepared to participate in those credits. The notion of the market being closed is simply wrong." This is good news for APP, in particular, which has since been able to refinance part of its US$9 billion debt.

The Urge to Merge

The level of risk undertaken in debt refinancing or capital raising for expansion these days, however, pales in comparison to the risks of going for a merger or acquisition. For example, a gutsy M&A can stretch a deal across borders, across currencies or even across continents. In terms of funding, it can be done via cash, share swaps, debt or a combination of any two or all three. While no formula applies, certain patterns are beginning to evolve as the number of Asian M&A deals steadily increases.

Orders of ABN-Amro, for example, says that M&As in Asia will increasingly be financed by a combination of debt and equity. "We see the M&A business financed by bridge financing initially, say a 12-month bridge, and that bridge will be taken out by various capital markets instruments, whether equity, debt or a combination. That's the typical process." A classic example was the PCCW deal earlier this year, which obtained a US$12 billion bridge loan to partly fund its acquisition of HKT. Considering the carrying costs of 115 basis points above Libor on the first year climbing up to 400 basis points on the third year, treasurer Michael Verge has said PCCW will come to the market later to refinance it.

Share swaps, by contrast, have been occurring in mergers between two players in the same sector, in the same country. "Where a vendor wants to merge and effectively remain a shareholder in a large group, the issue is the relative valuation of the acquiring company," explains Orders. "So [the acquiring company] has to reach an agreement on what proportion of the merged group the shareholders of the vendor company should be entitled to. Those sorts of mergers normally occur to businesses within the same sector, so the argument becomes of relative valuation. You both have a certain financial configuration, market share and branding. What does that mean in terms of the shareholders of the vendor company, and what shareholding they should be entitled to in the merged group?" This happened when Globe Telecom in Manila acquired 100 percent of Isla Communications, which was partly owned by Deutsche Telekom (see "DealWatch," May 2000).

Relationship also counts a lot in how an acquisition is executed. When the Indian Internet company Satyam Infoway agreed last year to acquire 100 percent of IndiaWorld Communications, which runs the leading website for overseas Indians, it planned to carry out the deal in cash. The company handed IndiaWorld's owner, Rajesh Jain, US$28 million in cash for an initial 24.5 percent stake, and an additional US$12 million in deposit for the rest, in September last year.

But after nine months of interaction, Satyam Infoway's management found comfort in working with Jain. That comfort was reciprocal and Jain approached the company to just pay him in shares and give him a permanent role as Satyam's advisor. T.R. Santhanakrishnan, CFO of the Nasdaq-listed company is no fool - he approved the proposal.

"The reason why it was an all-cash transaction initially was we thought Jain would just monetize our shares if we paid him with stock, and we want a controlled monetization of our shares through our investment bankers," Santhanakrishnan says. "But later we formed a strong chemistry and he had become a part of the team that strategizes the business development process. We paid him with the unlisted Indian paper, not the Nasdaq-listed paper, and this demonstrates his confidence in the company." Deals like these, of course, are ideal for both sides.

Cash or Charge?

Meanwhile, a large company acquiring a distressed company would most likely do so in cash, simply because cash is what the seller needs to restructure or invest elsewhere. Indeed, Hong Kong conglomerate Wheelock used cash when it began to purchase a controlling 51 percent stake in Joyce Boutique Holdings in June. The retailer had suffered successive years of declining revenues and rising losses due to a slump in demand for high-end brands. Wheelock's HK$400 million (US$51 million) offer closed the deal quickly.

Cash is also king in cross-border acquisitions, but this is largely because cross-border share swaps in Asia are extremely rare. "The constraint in doing share deals [across borders] is that you need to have a certain level of investor acceptance and sophistication," says David Livingstone, managing director and head of M&A at Goldman Sachs in Singapore.

Regulators, however, are just as much of a barrier as investors when it comes to cross-border share deals. "A company coming from one jurisdiction offering its shares in another jurisdiction has to overcome all the issues relating to its disclosure about shares. It has to be able to say where its shares are going to be listed, and in what currency. What are the dividend impacts, say, for a Korean company issuing shares in Indonesia, when they have set their dividends based on the fact that most of their shareholders are in Korea, receiving Korean won dividends? There are no hard and fast rules, but for cross-border deals within Asia right now, cash is the more used currency compared with shares," Livingstone says.

Some brave souls, however, are starting to squeak past these barriers. Littauer Technologies, a Korean Internet company listed at the small-cap Kosdaq exchange, bought all of AsiaNetCorp, a Hong Kong Internet company, via an all-stock transaction worth US$1.3 billion in July. The deal reflects both wit and ingenuity. "It's actually a two-way cash and stock transaction," says Richard Lee, director at Littauer. "Because there is no stock swap in Korea, what we have done is we have taken cash of the company [Littauer], and [AsiaNetCorp] shareholders take that cash and subscribe back to our shares. Technically it's an acquisition, but the effect is a stock swap. But in order to get past regulatory purposes, we have to say it's a pure acquisition even if the end result is a stock swap."

The preparation for a deal like this can take months, but the more time spent, according to CFOs, the lower the risks and the better the execution. Lim How Teck, CFO at US$4.3 billion-a-year Singapore-based Neptune Orient Lines (NOL), is currently in the midst of such planning. He has already set aside US$150 million from a rights issue in 1999 to fund the expansion of its logistics business through an acquisition. With a gearing ratio currently of 2.8 to 1, Lim says he would have to rethink using cash to acquire a company with a price tag of more than US$100 million.

"We'd like to keep our gearing on an even keel, and in a big purchase, one has to have a combination of outright cash and a few other things," Lim says. "If we go and buy a company with assets of US$50 million to US$100 million, we probably could get by without any share swaps. But on the other hand, if we buy a company worth US$500 million, then we have think what sort of equity interest we are taking in that company."

The equity question is also becoming more crucial in other ways. For example, the nature of the deal changes significantly depending on whether NOL acquires a software or hardware company for its logistics operations. "A lot will depend on the intellectual property involved. If you're buying a company with a lot of goodwill, through its people, software or franchising value, then one can't simply acquire 100 percent, because you need an incentive for the staff to be around and work with you. It's not an issue with hardware, so we can acquire hardware 100 percent," Lim says.

When Big is Better

While NOL did a successful rights issue, few Asian companies have yet to plunge into the local bond markets to finance their expansion plans. For the most part, the slow take-off of the local bond markets can be blamed on the lack of a liquid secondary market - most fixed-income investors in Asia are still stuck in the buy-and-hold mentality. But some signs of life are starting to sprout. The Thai Bond Dealing Centre, which provides the infrastructure for secondary trading of baht-denominated bonds, reported that new issues of corporate bonds in 1999 soared to 289 billion baht (US$7 billion) from 38 billion baht in 1998. Rating Agency Malaysia, which assigns credit ratings to ringgit-denominated debt issues, and the Surabaya Stock Exchange, where most rupiah-denominated bonds are traded, also cite an increasing trend in their primary markets.

Meanwhile, investors continue to lap up anything with government backing. Hong Kong's government-owned Kowloon Canton Railway Corp. (KCRC), for example, has had no trouble attracting buyers for its issuances. "[We've had] very good financial results over the last 15 years, and the company has a good future because [mass transit] is a strategic development; it's a necessity," says KCRC CFO Samuel Lai. Under Lai's guidance, the Hong Kong railway builder and operator has raised US$2 billion in ten-year bonds in the past year. Carrying the sovereign rating of A3 by Moody's and single A by Standard and Poor's, KCRC paid a coupon of 7.25 percent for its offering in July 1999, and 8 percent in March this year - quite low compared with the 9.875 percent coupon the Philippine government had to pay when it raised a US$600 million ten-year bond issue in the same month.

Lai also has advice on how to lower the cost of funding: don't approach the market only when you need the funds. KCRC is building four extensions to its line linking Hong Kong to the Chinese border at Guangdong, and another line connecting Kowloon with Hong Kong island. The HK$78 billion (US$10 billion) project, scheduled for completion by 2004, just started last year, and with a HK$29 billion equity injection from the Hong Kong government, need for funding is a long way off.

"But because we understand that today's financial market is volatile and sentiments change easily, we have adopted a policy of going to the market to pre-fund [whenever the sentiment is positive]. We don't want to wait until the moment when we need the money and the market works against us," Lai says. Now, KCRC is re-investing the funds it raised from the two foreign bond issues, and the returns are more than enough to shoulder the cost of coupon payments.

Of course, not everyone is protected from the risk game like a government-owned monopoly. Some accuse KCRC of abusing its shareholders' trust by raising money before it's needed, and simply turning it over to purchase foreign bond issues. In other words, rather than acting like a bank, it could be involved in higher-return activities of its own.

A more commendable and innovative deal is a recent zero-coupon bond issue in Malaysia. Lekir Bulk Terminal (LBT), which is undertaking a project for a wholly owned subsidiary of state-controlled power firm Tenaga Nasional Berhad (TNB), obtained 248 million ringgit (US$64 million) in funding by using a complex bond structure. Arranged by HSBC Bank Malaysia in July, the zero-coupon bonds come in 19 series, each one redeemable semi-annually from 2003 to 2012. The structure provides for the bonds to be redeemed through a concession agreement entered into by LBT and the TNB subsidiary. It won an AA3 stamp from Rating Agency Malaysia.

"The bonds were fully subscribed, with the short- and medium-term tranches oversubscribed," says Jerry Yeoh, head of debt capital markets at HSBC, adding the deal appealed mostly to insurance companies and provident funds. LBT, like KCRC, however, benefited from the comfort factor of a certain level of government backing. Imogine Baker, investment analyst at Barclays Capital in Hong Kong, points out that investors flock to sectors that would inevitably get government support in times of distress. "These are industries which, if they should fail or go wrong, the government will have to bail them out, like telecommunications and power. These are companies that governments cannot afford to see fail, plus they also have attractive assets," she says.

Back at Indofood, of course, no such comfort factor exists. If things go well in terms of cashflow and managing its outstanding debt, then it might be in a position to expand its brand. Says CFO dela Cruz: "If my debt capacity is still there, then I'll leverage it to the extent that I can. If that's not enough, if I can convince the shareholders that the acquisition is a good buy and a good fit for Indofood, then maybe we could raise additional capital via a rights issue."

This, of course, will require a careful assessment of the risks and the courage to take action. To do anything else, however, would be living even more dangerously.

Abe De Ramos (abederamos@ economist.com) is a senior writer for CFO Asia