ACCESS PREMIUM
With interest rates still low, why are finance managers in Asia paying a premium for their money?
By Abe De Ramos and Tom Leander

Call it the ultimate in white-knuckle financing. Cesar dela Cruz faced a cash shortfall on US$200 million in loan payments this month. By the last week of May, the finance director of Indofood Sukses Makmur had done nothing. The most attractive solution - to refinance in the US-dollar bond market taking advantage of historically low interest rates - remained bolted shut. The alternative, to cut costs and enter into high-cost loans with Indonesian banks, was about as attractive as cutting off his right arm.

Then, on May 28th, relief came. For the first time, Standard & Poor's and Moody's rated Indofood. Citing its strong management, the agencies awarded the company B/B3, one notch above the beleaguered Indonesian sovereign. Indofood's spread tightened and dela Cruz announced an 11th-hour offering.

But he was in no mood to celebrate. His scramble had given him a clear view of the high barrier blocking Asian companies from entry to the global capital markets. Indofood is regarded by analysts as one of the region's best-managed companies. But because it hails from troubled Indonesia, it was off global investors' radar before the rating agencies weighed in at the last minute. For months, dela Cruz couldn't get meetings with debt market bankers. "Treasury rates were coming down," says dela Cruz, "but we couldn't get the benefit."

Access Denied

The fact is, despite the low interest rate environment, the majority of Asian companies are missing out on cheap debt-market funding. Investors have remained too averse to diversify their risk portfolio, so liquidity tends to stay in a handful of Asian names (see box). For those who do not belong to this club of corporate elite, the access premium for the privilege of borrowing from global investors is still too high.

As a result, Asian companies have simply been reluctant to tap the bond markets. While US and European companies issued record levels of bonds in 2001 and continue to do so this year - most of them driven by refinancing, according to Standard & Poor's - Asian companies have been slow to take advantage of the 40-year-low interest rates.

In the first five months of the year, Asian companies and sovereigns together raised US$17 billion from the international bond markets, according to US-based market data provider Thomson Financial. This is about half the US$37 billion raised in all of 2001, but fewer issues are expected in the rest of the year as interest rates rise. In any case, these figures pale in comparison to the heydays before the financial crisis of 1998, when key US interest rates were far from the current 1.75 percent.

Lackluster response is even more evident in the syndicated loan and domestic bond markets. According to US-based market data provider Dealogic, in the first quarter of the year syndicated loans fell 73 percent to US$15 billion, from US$57 billion in the same period last year. Domestic bonds fell 28 percent to US$16.3 billion.

These figures reveal an intriguing irony: Asian borrowers had more appetite for debt before the US entered a recession, and withdrew after the Federal Reserve began its historic series of rate cuts, which Asian countries almost immediately followed.

It doesn't take a genius to know that a low interest rate environment presents a great opportunity to lower the cost of capital. But even in a period of slow economic growth, CFOs can do at least one of three things: refinance existing debt, support capital expenditure, and be opportunistic by locking in to long-term funding.

Many of the deals seen this year have been related to funding acquisitions. "What you haven't seen is people saying, 'It's an ideal time to borrow and I should be doing it. I'm getting very cheap short-term funding, and I'm going to average that out,'" says Patrick O'Brien, head of debt capital markets at UBS Warburg in Hong Kong.

Extending the term of liabilities, he argues, should improve share prices, because investors will know that refinancing risk will be lower. "A lot of people have been reluctant to do that, and it flies in the face of sound business logic," O'Brien says. Investors want to buy business risk, not financial risk, and they don't normally want to see the companies they invest in having to face liquidity problems. "A lot of that consciousness has not moved across to Asia," he says.

Against the Grain

So where has this left companies in the fringes of creditworthiness? Those that have entered the markets have resembled jugglers, balancing the problems of low credit rating, high-cost borrowing, and a need to refinance. Philippine Long Distance Telephone Company (PLDT) is the most obvious case of the mixed appeal of this approach.

The fixed and mobile phone provider raised US$350 million in a twin offering of five- and ten-year bonds in April to finance bonds maturing in 2003 and 2004, for which it is paying 8.5 percent and 10.635 percent, respectively. The issue gave a breather to its liquidity. "We recognized long ago that there was a mismatch between our cashflow versus our debt repayment schedule," says Annabelle Chua, PLDT's treasurer. "And even though the cashflow of the business continued to grow steadily, we still had a problem," she says. PLDT's management committee worked with bankers Morgan Stanley and Credit Suisse First Boston to come to market in September, but the attack on the US intervened, playing havoc on spreads. They shelved the issue.

With the bond payment deadlines on the horizon, the situation was tense. PLDT had begun financing its expansion drive before the Asian crisis, eventually amassing a total of US$3.5 billion in debt. Some US$1.3 billion of that matures before 2004.

While the company saw an improvement in cashflow and earnings resulting from its investment in its mobile unit Smart Communications, analysts and creditors began to doubt the company's ability to expand fast enough to repay without a drastic effort at liability management, or face divesting Smart to meet the payments.

Few traditional sources were willing to lend a hand. In the fourth quarter of 2001 HSBC withdrew from an earlier decision to lend PLDT US$30 million. In February, PLDT was hit by another in a series of downgrades. Moody's Investors Service lowered PLDT from Ba2 to Ba3, and Standard & Poor's ratcheted the company's debt down to double-B from double-B plus. Then the Fitch rating agency downgraded PLDT's senior denominated ten-year debt to BB from BB+, noting the risk to the company's liquidity that bond payments would impose over the next two years.

Shrugging off the setback, Chua turned to an old source of funding. In the early 1990s, PLDT bought equipment from German suppliers and arranged long-term financing with Kreditanstalt fur Wiederaufbau (KfW), the German export credit agency. Chua now approached KfW for a US$149 million loan facility.

It was on generous terms: a nine-year loan to be disbursed over three years and with a two-year grace period. Interest rates from export credit agencies (ECAs) typically run between 3 to 4 percent per year. But there's a catch. Because the loans are to come in installments, that means PLDT can't be aggressive in its capital expenditure. Following KfW's loan, the Japan Bank of International Cooperation agreed to lend PLDT up to US$80 million.

These two breakthroughs presented Chua with a window to reenter the bond markets. Taking advantage of spreads that had now stabilized, rival Globe Telecom was preparing to launch a ten-year bond. It was time to weigh the pros and cons of that shelved bond offering. "We were always keen to react to the market, and the KfW loan resulted in some compression in the spread," says Chua. She adds: "It was a good anchor for us to go out with and deliver a story to investors."

The price they had to pay, however, was not attractive. PLDT paid 11.375 percent for its ten-year bonds, compared to 10.5 percent for the similarly dated bonds it raised in 1999. Interest rates on ten-year US treasuries were the same at 5.2 percent in April 1999 and March 2002.

To be sure, the 87.5 basis points difference reflected the rating agency downgrades, but the market still seemed to suggest that PLDT had gained in its Asian peer group, despite recent rocky years in the region's telecom industry. Barclays Capital in Hong Kong says the outlook for PLDT has improved from recent years, given the stability of the peso, improvement of the Philippine economy, and successful integration of Smart.

The news wasn't all bad for Chua. Looking beyond the high price, the bond offering contained a silver lining. The ten-year bond priced through secondary market levels of PLDT's benchmark bond, which comes due in 2009. The 2009 issue was yielding 11 percent at the time of the April twin offering, suggesting a price at 11.5 percent. But investor demand ensured that the premium to the benchmark remained tight, a sign that the market had regained some faith in the company.

It was a measured success, but Chua, like dela Cruz, remains leery of the bond markets. Although PLDT now has enough from its ECA loans and the proceeds of the bond offering to cover its US$1.3 billion in payments coming due before 2004, it may face another cash shortfall. PLDT expects US$150 million in dividends from Smart, but analysts say it should not be included in the parent's free-cashflow estimates, because Smart's own creditors haven't yet agreed to it.

But if Chua needs that US$150 million to meet PLDT's obligations, she has no plans to return to the global bond markets for them. "We'll go to more traditional sources, continue looking to the ECAs instead of a bond offering," she says. Translation: the access premium to the global debt capital markets is still too high.

The Master Plan

And what does Xu think of the fact that the merger is mandated by a ministerial authority? He claims he has absolutely no problem with it. "We are a listed company and CAAC fully supports our adherence to market rules," he says. CSA's parent group will absorb Xinjiang Airlines and Northern Airlines some time this year, he explains.

That's stage one. In stage two, the shareholding company, CSA, will get to choose which assets owned by the two airlines it would like to acquire, pending approval by its minority shareholders, of course. CSA Group will have no say in this because such an acquisition will be treated as a connected transaction since, by then, the two smaller airlines will be owned by the parent group. He is confident that CSA will get the green light from shareholders because the company will only take over operations that will add value to the operations.

Also, he believes that if Air China and China Eastern Airlines do the same, CSA can only remain competitive by merging. Otherwise, CSA will join the ranks of the 30-odd small regional players that are fretting because they will be severely disadvantaged by the bulk of the CAAC giants. Aviation experts agree. Independent aviation consultant Peter Harbison of Sydney-based Centre for Asia Pacific Aviation says the mergers are an essential development for China's aviation sector. He explains that globally the sector is changing rapidly. "China has to consolidate, really, before the country further opens up its aviation sector to the rest of the world," he says.

Harbison says the same process of consolidation in Europe and the US took two to three decades. "There, the strong international operators were able to grow from a strong, captive domestic market. China's domestic market is fragmented and competition is unstructured," he says. The proof can be found in the figures: in 2000, CSA's net profit margin was 3.3 percent. The margin for Hong Kong's Cathay Pacific was 14.5 percent, and for Singapore Airlines, 15.6 percent, though CSA is expected to suffer less from the September 2001 events than its international counterparts.

A Matter of Perception

PLDT's struggles make it a higher risk for investors. But many second-tier credits across Asia that have won the attention of analysts for a more promising strategy and tighter fiscal management have a prohibitively high cost of money, too. This ignores a trend in the second-tier market toward improved fundamentals across-the-board.

Says Raja Visweswaran, the head of debt capital markets research with Bank of America in Hong Kong: "The best trends are in the triple-B sector, which has a consistent improvement of profitability since the 1997 crisis period." He adds that the high-yield sector has shown deterioration in net margins after a brief period of recovery in 1999, but that the EBITDA margin is still relatively strong. "This points to high non-operating costs in this sector - finance costs in particular have been exceedingly high," he says.

The situation has a catch-22 flavor about it, drawing Asian CFOs into a vicious circle. In order for high-yield companies to bring their finance costs down, they must reduce leverage. In fact, according to Visweswaran, they have made greater strides in reducing leverage as a sector than single-A or triple-B rated companies.

But that means, to continue improving fundamentals, they have to avoid borrowing from bond investors anytime soon. Which means that they remain only spectators at the current banquet of low-cost money and tighter spreads for well-known credits. Cruelly, even bankers admit that some of those better regarded big names may not deserve the rating.

Cesar dela Cruz, who is deputy president in charge of finance at Indofood, knows all about this conundrum. "Perception is our number one problem," he says.

Dela Cruz is facing a liquidity challenge: US$200 million in mostly foreign currency debts are coming due in June, and cashflows are only sufficient to sustain working capital and capital expenditure this year. Indonesian banks are not lending even to blue chips, and are instead investing their funds in government securities, which pay an interest rate of 16.5 percent. Dela Cruz has ruled out the syndicated loan market, his main funding source prior to the crisis. "Even if we wanted to, there aren't that many banks scrambling to get our business," he says.

The reason is simple: since the Indonesian economy fell apart five years ago, foreign governments have restricted commercial lending to Indonesia. In Japan, for example, lending to Indonesia has to be approved by the central bank, and banks immediately have to provide for losses of 100 percent of the loan amount. "If they lend to us, they have to immediately provide (for potential losses), so it's going to hit their profit and loss accounts," says dela Cruz. "It started during the crisis of 1997, and they're still holding back," he says.

So in late May, dela Cruz announced the inevitable: a US$200 million bond issue, Indofood's first-ever. Although the issue would actually increase his cost of capital, it was still his cheapest source of funds. Dela Cruz is currently paying 140 basis points over Libor, which means a total of less than 4 percent, for his loans falling due. With the Indonesian risk-free rate at 16.5 percent, he estimates his cost of equity at 20 percent. Including other loans maturing in the future, his weighted average cost of capital is 16 to 17 percent. With a return on equity last year of 23 percent, dela Cruz says Indofood is still able to generate value. Dividends last year were 30 percent of net income.

The challenge for dela Cruz now is how to sustain that, given the rise in his cost of capital with his planned bond issue. That doesn't include the cost of hedging foreign exchange exposure, which is a necessity as Indonesia remains in dire straits. Dela Cruz has engaged in principal-only-swap (POS) arrangements for his total foreign currency debt of US$345 million. POS gives dela Cruz the right to buy dollars at 4,000 to 4,500 rupiah, about half the current exchange rate of 8,900, to pay the principal. The cost is an annual premium he pays counterparty banks to maintain this right.

But at least Indofood got what dela Cruz predicted: a credit rating higher than sovereign. In late May, Standard & Poor's and Moody's announced Indofood's single-B and B3 ratings, respectively, a notch higher than the sovereign's triple-C, or just above default. "I think they were concerned with our short-term liquidity, so we needed to prove that we have the capability to pay on time, that there are back-up facilities that will allow us to pay the debt," he says. This Indofood could do by reducing operating costs, delaying capital expenditure, and dipping into bilateral arrangements with banks with whom Indofood has had a longstanding relationship.

These, however, are worst-case scenarios. A strengthening rupiah, stabilizing sociopolitical environment, and reviving economy are all working well for domestic demand, which still makes up 88 percent of Indofood revenues. The company saw a 15 percent increase in revenues and profits last year, and sales are expected to grow 10 percent annually over the long term.

Early indications point to a coupon rate of 10.5 to 11 percent. In any case, dela Cruz can count on at least a 9.75 percent coupon for his five-year debt. That's the amount paid in April by Indonesian mobile phone provider Telkomsel, which is rated single-B plus by Standard & Poor's.

Parental Guidance

In fact, 9.75 percent could be generous for Indofood, because it doesn't have a double-A rated, Singapore-government-backed company behind it. The 35 percent shareholding of SingTel in Telkomsel (the rest is owned by Telkom, the state-owned fixed-line operator) was more than just a feather in its cap. Analysts said its US$150 million, five-year bond deal was seen by investors as a high-yield play on SingTel; in other words, the merit of the Telkomsel bonds rested heavily on the assumption that SingTel is in it for the long haul. "The increasing presence of SingTel is a major plus in keeping the lid on the type of management shenanigans that pervaded many companies in Indonesia," says Alan Greene, credit analyst at Barclays Capital in Singapore.

Telkomsel achieved 532 basis points over US Treasuries for its bonds, and its coupon was superior to the 13 percent that Globe Telecom, also minority owned by SingTel, paid for its five-year paper in 1999. The issue was met with such healthy foreign demand that Greene calls Telkomsel a "freak". That's because similarly rated, Indonesian-owned companies did not do as well. Independent power provider Medco Energi, also rated single-B plus by S&P, had to downsize its issue to US$100 million from US$150 million, and paid a premium of 585 over Treasuries just a month before. "Medco's reception is a better reflection of the overall tone of the market and would be more typical of most issuers," notes Greene.

What a difference SingTel makes. When Telkomsel's CFO Jusuf Kurnia sought foreign banks for loans last year, only two banks came to help, and gave very short maturities. Deutsche Bank was so skeptical about Telkomsel's foreign exchange risk that it offered a one-year, 500 million rupiah loan. Citibank, on the other hand, gave Telkomsel a US$72 million facility, with a maturity of seven months. "Banks then had very little confidence in Indonesia," he says. "Deutsche spent four months to investigate us, and Citibank about six months, with people coming from London, the US and Hong Kong," says Kurnia.

Now, Telkomsel has a lot going for it, especially if it achieves its lofty goals. It's the largest mobile phone operator in Indonesia, with a market share in excess of 50 percent. With a penetration rate of 3 percent in a population of 215 million, Kurnia says he can achieve a 30 percent cumulative annual growth rate (CAGR) between 2002 and 2006, to reach 13.2 million subscribers. He also expects EBITDA for the five-year period to reach US$5.2 billion - a 32 percent CAGR from this year's estimated US$550 million. That's assuming the rupiah will be stable at 10,500 per dollar.

Kurnia says his edge over competitors is network coverage - Telkomsel can reach 80 percent of the population, versus 40 percent for Satelindo and Excelcom - and financial strength. His debt to EBITDA, including proceeds from the bonds, is 0.27, very low for a telecommunications company. With a capex plan of US$2.1 billion in the next five years, Kurnia believes in leverage, but as a company that will inevitably be listed and subject to a wider shareholder base, he is mindful of his cost of capital. So, like PLDT's Chua and despite his recent success, he's looking to ECAs to support a further US$300 million of capex this year.

"We have financing options like ECAs, because we have long-term contracts with vendors," says Kurnia, referring to Finland's Finvera, Germany's Hermes and Sweden's EKN, the ECAs that support projects with mobile leaders Nokia, Siemens and Ericsson. "The interest rate is about 3 to 4 percent a year, compared with bonds where we pay 9.75 percent," he says.

Until the high cost of access to global bond investors eases, don't expect him to be calling his debt market investment bankers anytime soon.

Tom Leander is editor-in-chief and Abe De Ramos is a senior writer at CFO Asia.