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Tuesday, 24 October 2017

L&T pushes too hard with CB

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  • Larsen & Toubro manufacturing unit in Mumbai

Structured Equity

Investor snub derails hopes for Indian equity-linked revival, as underwriters take losses

A US$200m convertible bond from engineering conglomerate Larsen & Toubro reopened the Indian equity-linked market last Monday, only to promptly close it again after the deal failed to clear.

The bond, with a five-year bullet structure as required under Indian regulations, was launched at around midnight, Hong Kong time, with a fixed coupon of 0.675% and a conversion premium of 25%.

In a highly unusual move, the bonds were reoffered at 99–100 in the original term sheet, suggesting that the bookrunners had failed to find any takers at par and decided to swallow the difference.

Even at the reoffer price, investors appeared to be uninterested. The bond was quoted at 98/98.375 the following morning before India’s market opened, and had slipped to 97.375/97.875 as of 5.45pm, Hong Kong time. On Wednesday morning it fell further to 97.25/97.75 on heavy selling.

“At an offer price of 99, we’re not even seeing 99 fair value, and that’s using a 150bp credit spread, which is fairy-tale territory,” said one equity-linked banker away from the deal.

BNP Paribas, Standard Chartered and Citigroup were joint bookrunners. The non-alphabetical order of the leads suggested that Citigroup had underwritten a smaller chunk of the deal than the two others.

“It would be good for the market if they lost their shirts because it would introduce some discipline”

As the issuer is thought to have paid a 1% fee, the banks could in theory have avoided losing money if they had managed to sell at 99. The bonds were trading at 98.0–98.5 in the grey market before pricing, making it hard to argue a case for investors to buy at a point above the market price. On Wednesday afternoon, Hong Kong time, one of the leads was trying to offload its stick position at 98.0, then later at 97.5.

“We’re taking a long-term view,” said a source at another of the leads.

Aggressive

Seven to 10 banks had been in final talks with the issuer, but most were forced to drop out due to the aggressive terms L&T had demanded. The issuer was set on a conversion premium of 25% and a yield of 1% or lower. Three banks had pitched coupons of 1.00%, 1.25% and 1.50%, but were not comfortable going any lower.

“This had all the right ingredients,” said one Asia CB head. “It was low-risk, in a market that had been closed for a long time and so had few price references in a very outright-focused market and a structure that was straight down the line. It meant the banks were only really bidding on the coupon.”

Most Asian investors had signed off for the night when the deal launched. Even a lot of the big European outright investors that normally participate in Asian deals had gone home, and those that saw the deal were underwhelmed at the lack of momentum from Asia. The absence of asset swaps also made the deal less attractive to hedge funds. Still, some outrights were drawn to the stock and the scarcity value of high-quality Indian paper.

At par and at an assumed credit spread of 175bp, lower than the 200bp many investors were using, implied volatility was a high 31.6% and the bond floor was 86.5. At 99, implied volatility was still high at 29.6%, above the 25% level some investors had wanted to see. Stock borrow was available at 3%–4%.

“The trouble with Asia is all the deals are three years, so no one ever gets wrecked,” said another equity-linked banker. “At five years, you can lose a lot of money. In a way, it would be good for the market if they lost their shirts because it would introduce some discipline.”

Almost all Asian CBs have five-year tenors, but with investor puts at the end of the third year.

This was the first new Indian CB issue since Jaiprakash Associates raised US$150m in September 2012.

L&T’s share price was little changed last Tuesday morning after the deal was completed, but then started to fall, closing down 2.4%, suggesting that some hedging was taking place. By Friday, the stock was down 4.6%. 

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