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Corporate bonds sweeteners

Publication Date : 28-04-2014

 

Major business conglomerates in the Philippines are today making full use of corporate bonds to meet the funding requirements of their expansion plans. With the Aquino administration’s public-private partnership (PPP) program on infrastructure projects finally getting off the ground, the companies that have won (or are joining) the bids are tapping the capital market for additional funds.

San Miguel Corp., JG Summit Holdings, Ayala Corp., Manila Tollways Corp. and, the latest, SM Investment Corp., among others, have tapped bond offerings to strengthen their war chests. As the competition for attracting investments from the public heats up, the conglomerates have to be more innovative in their funding schemes.

Although the traditional “vanilla” type bond offering, i.e., fixed-rate interest over 7- or 10-year periods, remains popular, it is slowly becoming passé.

The savvy investors—mutual funds, insurance companies, hedge funds, trust companies and under-the-radar deep-pocket investors—want more value for their money, both on the short term and the long run.  Recently, Ayala Corp. upped the ante on corporate debt instruments. It was able to sell $300 million worth of five-year bonds that carried a yield (or interest rate) of only 0.5 percent a year.

That’s just double the 0.25 percent interest that most local banks give to peso savings accounts. And to think that these bonds are denominated in US dollars which, to date, has an exchange rate of approximately P45 to $1.
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The low yield, however, is sweetened by the option given to bondholders to exchange their bonds for shares of Ayala Land Inc. (ALI), the real estate arm of Ayala Corp., at P36.48 a share, which can be exercised within a certain period prior to maturity on May 2, 2019.

The indicated share price represents a 20 per cent premium (or added value) to ALI’s market price as of the date of the bond offering. The offering is reputed to be the first equity-linked international issuance by a Philippine company in the past two years, and has the lowest financing cost among Asia’s capital markets this year.

According to reports, the offering was oversubscribed by 2.5 times the base offer. This is not surprising considering the exemplary financial track record of Ayala Corp., and ALI’s reputation as the most profitable real estate developer in the country. The bondholders who opt to swap their bonds for ALI stocks can, in the long run, get their investment payback either by way of dividends or by selling their shares later at a higher price.

The arrangement allows Ayala Corp. to enjoy the benefits of additional capital with low carrying cost and potential high-end investors in its real estate arm in case the bondholders decide to exercise their stock option.

To allay the apprehension of ALI stockholders about the possible dilution of their shareholdings when the stock option kicks in, Ayala Corp. has assured them that the stocks would be sourced from its own shareholdings.

As local investors become more sophisticated in their strategies, thanks to the easy availability of information in the Internet, bond offerings have to go beyond the traditional approach of using interest rates or shorter maturities as come-ons to attract investors.

Special features, or sweeteners, have to tacked on bond offerings if companies want their debt instruments to gain favorable market response. Poor or unsatisfactory reception could have adverse consequences on the company’s share price or reputation in the industry.

The more common forms of sweeteners used are warrants or options. Generally, these consist of giving the bondholders the right, as in Ayala Corp.’s case, to convert bonds to stocks, either common or preferred, at a pre-agreed price or a discount from the stock price at the time of its exercise.

Understandably, sweeteners (also called kickers or bells and whistles) entail additional costs that the company has to take into account before they are included in the offering.

Thus, for example, a company may suffer a loss if, at the time the option is availed of, the stock price goes higher than expected and the bondholders are able to buy them at a discount or a low price. The financial advisers of the company have to make sure the bond offering, with all its regular features and sweeteners, will, upon maturity and the succeeding years, redound to its financial benefit, not unexpected losses.

Some bond offerings in developed economies contain sweeteners that have yet to be tried in our country. In an “income-linked” bond, the company agrees to pay the bondholders a certain percentage of its profits if they exceed a specified level during the term of the bond.

This arrangement makes the bondholder, in effect, a creditor on account of his bondholding and a stockholder entitled to a share in the profits of the company.

A variation of this sweetener is the “floating rate” bond where the interest on the bond is determined based on the interest rate of government debt instruments at the time the interest is due plus a certain percentage, or the inflation rate within a given quarter.

The idea is, the bondholder is assured of interest payments that reflect the prevailing interest rate or the true cost of money during the term of the bond.

There is also the “dual or multiple currency” bonds where the bond is denominated in two or more currencies and the bondholder is given the choice of receiving payment in the currency he considers more beneficial to him.

This type of bond is usually issued by multinational companies that have investors in different countries. The advantage of this setup is the investor does not suffer from the foreign exchange risk that often accompanies the conversion of one currency to another.

In the Philippine context, these sweeteners may be considered revolutionary. Only time will tell whether our domestic companies will be daring enough to include any of these sweeteners in their future bond offerings.


 

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