(Bloomberg) — Debt that can become equity has become all the rage in Asia, where issuers are increasingly turning to the instrument to get cheap money in an environment of high interest rates.
The notes denominated in US dollars have raised more than $9 billion this month, a record for the region, data compiled by Bloomberg show. Alibaba Group Holding Ltd., JD.com Inc. and Lenovo Group Ltd. accounted for almost all the proceeds.
Convertibles, already common in the US and Europe, are increasingly becoming a favorite tool in Asia. For issuers, they offer unmatched flexibility to raise funds cheaply for things like buybacks without immediate stock dilution — both Alibaba and JD.com have massive repurchase plans. For hedge funds, it’s an opportunity to arbitrage between the bond and the stock.
Asia Pacific bankers are getting ready for more to come. The rebound in Chinese equities — those traded in Hong Kong are heading for their longest streak of monthly gains since 2021 — and the end of years of negative rates in Japan are making those markets particularly appealing to CBs.
“Traditional fund-raising methods such as corporate bonds or loans are less attractive given the high cost,” said Christina Ma, head of global banking for Asia Pacific at HSBC Holdings Plc. “We would expect more liquid companies that have access to capital markets at essentially zero cost through CBs to come to market. This would be attractive for them.”
Convertibles are popular when borrowing costs are high because the hybrid notes’ equity component typically means interest rate payments are lower than on regular debt. They also give investors the chance to profit should the underlying stock rise.
For big Chinese names that are just starting to rebound from slumps in the past two years, the notes can offer access to dollars that will help pay for American Depositary Receipt buybacks without having to navigate Beijing’s capital controls. Alibaba and JD.com mentioned part of the proceeds from their CB offerings was to fund share repurchase programs in the US.
In Japan, homebuilding firm Daiwa House Industry Co. said earlier this year it would sell ¥200 billion ($1.3 billion) through convertibles denominated in yen, also to help fund buybacks.
“What these companies did was basically a very good way to get money and buy back shares,” said Selina Cheung, co-head of Asia equity capital markets at UBS Group AG in Hong Kong. “It wouldn’t be surprising to see more companies coming to market with the same strategy.”
Taiwan iPhone maker Hon Hai Precision Industry Co. launched the CB issuance spree this month, when it said it intended to raise as much as $700 million in what was expected to be the largest such offering of the year for an Asian issuer. Just days later, Alibaba came out with its record sale.
Strong Demand
The notes sold by the Chinese e-commerce giant and JD.com attracted strong demand from hedge funds interested in an arbitrage opportunity that was crushed during the financial crisis. In a typical trade, investors would go long a convertible bond while shorting the underlying stock, allowing them to profit from the short if the shares fall or convert the bond into equity on maturity if they rise — all while getting coupon payments.
“The hedge fund investors of the convertibles need to short stock as a hedge, and the company can take advantage of that supply of shares to execute a highly efficient buyback,” said Rob Chan, head of equity-linked origination for Asia Pacific at Citigroup Inc. “This also mitigates impact on stock price during marketing.”
Also read: Hedge Funds Return to Bond Trade With Checkered Past
In an entirely different approach to JD.com and Alibaba, Chinese PC giant Lenovo is planning the sale of $2 billion worth of zero-coupon CBs to Saudi Arabia’s sovereign wealth fund. The agreement is part of a broader strategic pact that includes a plan to build a research and development center in the kingdom and expand production capacity in that region.
“Historically, companies that have issued converts have been mostly unrated because rated companies would typically go to the straight bond market,” said Saurabh Dinakar, co-head of Asia Pacific global capital markets at Morgan Stanley in Hong Kong. “But given how high interest rates are, more investment grade companies are thinking about using the CB market as a way to reduce the ongoing cash-coupon cost.”
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