37 ASIAN LEGAL BUSINESS – JULY 2024 WWW.LEGALBUSINESSONLINE.COM Taiki Ki, a capital markets partner at Linklaters in Hong Kong, points out that the trend of companies issuing equitylinked financing instruments has been seen globally over the past few years in a rising interest rate environment. “However, with the recent rebound in Chinese equities, we are seeing significant renewed interest in this product in 2024,” notes Ki. This optimistic sentiment is shared by Skadden’s Stone and Sze. They believe that convertibles and other equity-linked products often serve as a gateway to primary equity markets. “The hope is that the nancing activity from convertible bond issuances and similar transactions will drive other deals, particularly IPOs, of Asia-based issuers,” say Stone and Sze. EQUITY SWEETENERS For issuers, one of the primary attractions of convertible bonds is their low funding cost. Under this circumstance, equity-linked instruments such as convertible bonds will remain popular as the value of the embedded equity will lower interest payments, according to Ki. Take Alibaba as an example: The interest rate on its recent convertible bond is 0.5 per cent. However, the rate on comparable term ordinary bonds previously issued by Alibaba would have exceeded 5.1 percent, according to estimates from market institutions. “Before conversion, convertible bonds can swap high-interest debt for low-interest debt. After conversion, they can lower the debt ratio and improve the company’s debt structure,” Tian explains. Another perceived advantage of convertible bonds is the instrument’s ability to help well-performing domestic companies expanding overseas gain higher access to foreign exchange reserves and reduce transactional losses caused by exchange rate fluctuations. In addition, convertible bonds have been increasingly winning the favour of investors. Apart from lowering interest payments in a high-rate environment, “such instruments offer significant arbitrage opportunities between the bond and the underlying equity for certain types of fund investors, allowing such investors the ability to manage volatility arising from external factors such as market movements and for issuers from certain regions and political tensions,” Ki adds. Given these characteristics, convertible bond issuances tend to be popular amongst industries such as technology, the internet, new energy, and biotech. “These sectors have high growth potential, high capital needs, and significant stock appreciation potential. From the perspective of both the company’s financing costs and the investor’s returns, convertible bonds are more appealing,” notes Tian. What made Chinese technology companies one of the biggest players in this space recently was their robust balance sheets and a strong credit profile, coupled with volatility in the share price that bumped up the value of embedded equity option. As such, equity-linked securities, including convertible notes “offer a compelling narrative for investors through the combination of strong downside protection with potential for equity upside, including from investment grade companies which historically may have been able to source pure debt financing at a cheaper cost,” explains Ki. CONVERTIBLE STRATEGY The recent wave of convertible note offers have had a notable common feature: Issuers such as JD.com, Alibaba, and Trip.com have concurrently executed share buybacks in a bid to ease any dilution effect. Indeed, there has been initial skepticism that any future conversion of bonds into shares might dilute the company’s equity. But, as Tian explains, concurrent share repurchases can offset the dilution effect, attracting long-term investors who are bullish on the company’s growth, thereby supporting the company’s sustained development. Convertibles issuances pared with a share buyback from the issuers are intended to match two significant liquidity events, according to Ki. Those are “the hedging from convertible bond investors” and “the share buyback from the issuer for a highly efficient execution with minimal disturbance to stock price”. Ki believes that it is beneficial to both the issuer and the investors. Skadden’s Stone and Sze note that apart from making stock purchases, some issuers have also used a portion of the proceeds to purchase derivative instruments (known as call spreads) from the underwriters, which have the effect of raising the effective conversion price for the issuer. Beyond flexible combinations, convertible bonds could also be strategically tailored to meet company needs. For instance, while some notes were offered to the public, Lenovo Group targeted a specific $2 billion zero-coupon convertible bond to a subsidiary of the Saudi sovereign wealth fund. “This illustrates the breadth of financing strategies involving convertible bonds, from pure fundraising and enhancing capital structure to strategic investments,” says Ki. Tian further unpacks the variety of strategic purposes underpinning convertibles issuances. “Some convertible bonds are publicly offered, typically by companies with higher ratings and better market reputations, attracting more investors and boosting market confidence,” she says. “Others are aimed at specific buyers, showcasing the close relationship and potential for further cooperation between the investor and the company. Companies will choose issuance strategies based on their specific circumstances and needs,” Tian adds. All in all, lawyers agree that the approach that an issuer takes largely hinges on its objectives and the level of perceived demand for the funding instrument from different classes of investors. In addition, “some issuers may choose to pursue private transactions to enable negotiation of more bespoke terms than would be available from a wider investor base, target a smaller number or particular type of holder (e.g. longer-term holders such as sovereign wealth funds) or for strategic reasons (e.g. the holder may provide business synergies to the issuer),” say Stone and Sze. CORPORATE FINANCE
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