PUT IT PROPERLY
Things a paranoid CFO should know about issuing convertible bonds in a downturn.
By Abe De Ramos

Two months into the year and still no initial public offerings in the pipeline, much less on the table. Needless to say, CFOs in Asia still believe the equity market will remain hostage to the uncertainty triggered by adverse events happening elsewhere in the world.

Three Taiwanese companies, however, managed to raise a combined US$500 million at the convertible bond (CB) market before the Chinese New Year. Convertibles are essentially equity issues with a hybrid of bonds; most of its buyers are still outright equity investors and hedge funds. Investment bankers are predicting the CB market will be hot this year, not least because of the likelihood that SK Telecom of South Korea will raise the biggest-ever CB issue in Asia.

The benefits of convertibles are obvious. For issuers, they are a cheap cost of funding as most recent CBs lean towards a zero coupon. And to investors, they offer the potential to cash in on the issuer's shares when they zoom. This is where CFOs need to be careful. Investors convert the bonds to shares through a put option, and they always get a premium over the current market price of the shares. The concern for bankers and CFOs nowadays is the length of time they would give for investors to exercise the put option. One of the reasons US conglomerate Tyco International came to the brink of disaster is that it faced the threat of paying out nearly all of its US$4.5 billion convertibles, because its share price had dropped and the put option was coming due.

Because of that, bankers now argue that a short put option can be harmful in uncertain times because investors may convert at a time when the issuer is short of funds. Says Julian Hall, director at Credit Suisse First Boston in Hong Kong: "The criticism in the US now is that a lot of companies have gone for a very short one- and two-year put." Tyco, which has gone aggressively for short put structures, is now struggling to refinance its debt.

At A Price

AThe Taiwanese companies that issued CBs with annual puts last year are, thankfully, doing well. But the mentality is changing, as the three electronics companies that issued CBs so far show. Macronix and Siliconware had two-and-a-half year puts, while Ritek had three. "They are extending the puts and realizing that although there is a cost for longer term financing, there is also a benefit," says Hall.

That cost refers to the put price, a figure influenced by the conversion premium and measured as yield-to-maturity. The longer the conversion period, the higher the put price. Macronix and Siliconware have a yield-to-maturity of 3.55 and 2.25 percent respectively, while Ritek has 6.29 percent. Ritek's is a huge difference given that its conversion period is only six months longer than the other two. This, in turn, is determined by at least two factors. One is the steep yield curve of US treasuries against which the issues were priced. As of writing, the spread between two-and three-year treasuries was 150 basis points.

Still, Ritek appears to have paid dearly. Here lies the second factor: unlike Macronix and Siliconware, Ritek has no American depositary receipts (ADRs), which investors could use to arbitrage. The existence of ADRs, called "stock borrow", allows investors to hedge their CB exposure, so issuers with stock borrow would normally get the more favorable price.

Did Macronix and Siliconware achieve this? Oh yes. Ritek's 6.29 percent yield to maturity meant it had a 250-basis point difference over US treasuries. Macronix had 15, Siliconware -69, says arranger Morgan Stanley.

And if it isn't yet obvious, CFOs should note that convertibles are not for all. Taiwanese companies lead the pack because technology is still a high-growth sector, so the stock price upside potential is huge. Says Jonathan Fouts, director at Morgan Stanley in Hong Kong: "If you (the investor) don't have a high-growth company, you won't have the benefit of selling essentially at a premium, because the conversion feature won't be as attractive." Food companies, keep out.

Abe De Ramos is a Senior Writer at CFO Asia.