AWSJ: Heard In Asia: Exchangeable Bonds Are Making Comeback
July 1, 2001
Dow Jones Newswires
By SARAH MCBRIDE
Staff Reporter
HONG KONG -- A once-commonplace financial product is making a comeback in Asia: the exchangeable bond.
These vehicles, which allow a company to issue bonds that can be converted into the stock of a second company, can pay off for all parties. For investors, they allow low-risk exposure to companies whose stock they believe is poised to rise. For issuers, they provide a tax-friendly exit from stock in companies that are no longer seen as core holdings. For the companies whose stock is affected, they prevent large chunks of stock flooding the market and putting downward pressure on the share price, says Dick Ma, a researcher at London-based Capital Data Equityware Plus, which tracks bond issuance.
In Asia, these bonds have had a resurgence since the crisis of 1997-98, says Rosa Wang, who manages an Asian convertible-bond fund at Dresdner RCM Global Investors. "The market over a three-to-five year horizon should be particularly attractive," Ms. Wang said. Capital Data Equityware counts four Asian issues this year; this time last year, just two companies had issued Asian exchangeable bonds.
Buying exchangeables can be tough for small investors. A good way to get exposure is to buy into one of the half-dozen or so Asian convertible-bond funds on the market. According to Standard & Poor's Fund Services, the top-performers are Parvest Asian convertible-bond fund, which returned 7.27% over the six months through June 15, and Dresdner RCM's, which returned 5.1% in the same period. By comparison, the average Asian ex-Japan equity fund declined 5.84%.
One reason to look at these bonds now: There's a good chance of further rate reductions this year. And, the potential upside looks attractive, with stocks in Asia appearing very cheap compared with their U.S. counterparts. Over the past year, the MSCI Far East Free ex-Japan index of stocks has fallen 34%, while the Dow Jones Industrial Average has risen 2%.
Here's how exchangeables work. Investors buy a bond, which comes with a lower interest payment than normal bonds. To compensate, they get the option to buy stock at a certain price. That price can range from about 15% to as high as 40% above the stock's current trading price, depending on the life of the bond and the strength of the underlying stock. Investors can convert the bond to stock at any time before maturity.
If the company's stock rises significantly above that strike price, it's a good deal. But if the stock tanks, the investors don't have to convert. Instead, they just hold the bond to maturity, and then get their money back with interest. Interest payments (known as coupons) on the bonds are typically in the 1%-3.5% range, and they're usually sold for terms of two to five years.
Some investors like the bonds because they're a good way to get exposure to an issue they might like, but would normally have to avoid because the company's balance sheet seems weak. Take the $467 million of Hyundai Motor bonds issued in May that can be converted into stock in Kia Motors. If Kia issued a convertible bond, its double-B minus rating from Standard & Poor's might make it off-limits for a bond-fund manager restricted to investment-grade issues.
But the Hyundai-backed bond offers a way in through the back door to Kia stock, because it carries a triple-A rating (Hyundai used a complex financing structure involving U.S. Treasurys to boost the rating and thus lower financing costs). Or look at Pacific Century CyberWorks, which is unrated by S&P: A Cable & Wireless bond that converts to PCCW stock is rated single-A.
For issuers, these bonds are a good way to raise cash from another group of investors. If they just sell the shares, they attract only equity investors. But if they structure the offering as an exchangeable bond, they can tap debt investors. In uncertain market climates like today's, a debt issue can mean raising more money than by simply selling stock.
Plus, selling off an equity stake in a noncore company can earn the company brownie points from the investment community. "In terms of corporate governance, it's generally viewed as more favorable," says Ms. Wang of Dresdner. If the sale is done through an exchangeable bond - the way least likely to damage the noncore company's share price - so much the better.
However, sometimes there's no way around causing a stock-price fall. When on Sept. 11, Hutchison Whampoa announced it would use a three-year exchangeable bond to unload part of its Vodafone stake, Vodafone shares fell 4.5% to 271.25 pence ($3.84). In January, Hutchison said it would unload more, and Vodafone shares fell 6%. Nevertheless, analysts say, the drops were a lot smaller than they could have been had Hutchison unloaded the stakes - totaling more than 2% of Vodafone - on the open market. Currently, Vodafone trades at 147 pence; the bonds convert at 310 pence for the January issue and 359.41 pence for the September issue.
That low stock price highlights a drawback for the issuing company. If the shares don't reach an attractive price before the bonds mature, the issuer is stuck with all the stock it was trying to unload, plus paying back the bond investors.
Another catch, this one for investors: Often, the exchange rate on these bonds is fixed. If the underlying currency happens to fall a great deal after the issue date, the investors who convert their bond into shares could end up losing money on the foreign-exchange rate. Of course, if the currency appreciates, the fixed exchange works as a protection.
In addition, the upside is limited if the bonds are callable, meaning the issuer can call the bonds back in and pay investors back. Take Cable & Wireless's two-year bond that converts into PCCW stock. If the stock ever rises 120% above the strike price of HK$3.60 (46.15 U.S. cents), Cable & Wireless can call back the bond. PCCW stock closed Friday at HK$2.20.
--------------------------------------------------------------------------------
URL for this Article:
interactive.wsj.com
--------------------------------------------------------------------------------
Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.
Printing, distribution, and use of this material is governed by your Subscription Agreement and copyright laws.
For information about subscribing, go to wsj.com
Used with permission of wsj.com |
