Deal Architect: Theatre produces intriguing play
The sector has already seen strong high-yield debt issues from Shimao Property, Greentown China, Agile Property and Hopson Development. In March, Lai Fung Holdings debuted in the high-yield market with a $200 million issue of senior notes due 2014.
What makes this issue remarkable is that unlike many of the existing China issues, which are relatively new businesses, Lai Fung came to market with some daunting legacy issues. Along with a questionable governance record – companies in the Lai Sun Group, of which Lai Fung is a member, were censured by the Hong Kong Stock Exchange in 2006 for questionable inter-group transactions – the Lai Sun Group defaulted on convertible and exchangeable bonds following the Asia financial crisis and a disastrous hotel investment and subsequently underwent a protracted financial restructuring.
It might make for an ugly picture, but investors have clearly forgiven and forgotten, based on the results of Lai Fung’s high-yield bond offering in March. The presence on the Lai Fung share register since 2006 of CapitaLand China, part of blue-chip Singapore-based property group CapitaLand, controlled by Temasek, which owns 20% of Lai Fung’s equity, helped sentiment. CapitaLand has proven itself one of the region’s savviest real estate investors, and fund managers were clearly impressed with their involvement.
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"Lai Fung is one of the smaller of the China plays, but it has a property management arm that offers an annuity-like rental income stream" |
A further challenge to the deal was the small size of the company’s China property portfolio relative to other comparables. With just 1.1 million square metres of development land bank, Lai Fung is dwarfed by other recent China high-yield plays such as Shimao, Greentown China and Shanghai Real Estate. The difference, says Mark Leahy, head of Asian debt syndicate at Deutsche Bank, is that Lai Fung’s asset portfolio offers more than simple development potential. "Most of the other China property high-yield offerings are a play on pure development potential," he says. "Lai Fung is one of the smaller of the China plays to come to the high-yield bond market but it has a property management arm to its business that offers an annuity-like rental income stream, which gives the business a more stable underlying cashflow profile than some of its peers."
Joint bookrunners Deutsche Bank and HSBC structured the deal as a seven-year non-callable issue. Rated B+ by Standard & Poor’s and B1 by Moody’s, both with a stable outlook, the issue also included an equity claw-back option for the issuer over 35% of the deal for the first three years at 109.125%, providing the company with a useful option to refinance the balance sheet into a rising equity market.
Light on covenants
On the buy side, investors were granted an effective put option at 101% of face value in the event of a change of control and a ratings decline, as well as a covenant package restricting Lai Fung’s and its subsidiaries’ ability to incur additional debt, make shareholder payments, create or incur liens, enter into transactions with affiliated companies and sell assets or merge with other companies.
Despite these restrictions, Leahy claims that the deal was effectively "covenant-light", especially given the historical difficulties associated with the credit.
"These covenants are relatively flexible when compared with the China property deals issued in 2006," he says. "This flexibility was acceptable to the investors in the deal with no pricing concession – the management team spent a considerable amount of time walking investors through the rationale for this flexibility and won the argument."
In fact, so convincing was the management on the roadshow that the deal was priced immediately after the Asian presentations with just conference calls with London investors. The deal was structured as a Regulation S issue, so there were no presentations in the US.
Despite the curtailed roadshow, the management team scored a 100% hit rate on investor presentations. In all, 133 accounts participated, with a total order book of $1.5 billion, leaving the deal more than seven times oversubscribed.
The issue priced within initial guidance at 9.125%, or 460 basis points over equivalent US treasuries and within existing comparable issues. Trading in the after market following the transaction has been impressive, with an initial tightening of around 50 basis points, suggesting that the leads got the pricing about right.
Most impressive, however, has been the performance of the Lai Fung share price during and after the announcement of the deal. After jumping more than 20% following the announcement, Lai Fung shares have since gained a further 10%.
While the Lai Fung deal clearly benefited from strong investor sentiment towards China property plays and high-yield issues in general, the key to the success of this transaction was in the execution, in particular the rehabilitation story surrounding the Lai Sun Group, as well as some clever structuring on the deal terms themselves. If the Lai Fung share price remains at current levels, an exercise of the equity claw-back option seems realistic, despite the current conservative gearing levels. If an enterprising investment bank can then sell a block of Lai Fung shares of that magnitude, then the company’s rehabilitation with the international financial community will be complete.