Posco to price ¥52.795 billion five-year zero-coupon exchangeables: market source

By Rebecca Melvin

New York, Aug. 7 - Posco was pricing ¥52.795 billion of bonds exchangeable into American Depositary Shares of SK Telecom on Thursday, according to a market source.

The five-year zero-coupon bonds were expected to yield 0% to 0.3% with an initial exchange premium of 23%, according to a Barclays Capital Research in London.

They are non-callable for three years and provisionally callable thereafter subject to a price hurdle of 120%. There is a put in year three, with yield to put indicated at 0% to 0.5%, Barclays said.

The exchangeable offers full dividend protection via an exchange price adjustment and takeover protection in the form of a change-of-control put.

Proceeds of the offering are to refinance its existing exchangeable into SK Telecom, which matures later this month.

South Korea's Posco, which is one of the world's largest steelmakers, isn't directly guaranteeing the exchange property, Barclays Capital said. Instead it is collateralized for the benefit of bondholders, who would have a claim on the collateral if they exercise exchange rights.

"Using 23% volatility, Libor plus 150 basis points credit spread and 80 bps stock borrow, we value the bond at 101.8-102.8 on worst-to-best indicated terms for investors," Barclays Research analysts Luke Olsen, Heather Beattie and Angus Allison said.

"This equates to a bond floor of 92.5 to 93.9 and an implied volatility of 18.4% to 20%. Incorporating a 5% skid in SK Telecom's ADS price, however, the implied volatility range on the new issue would become 20.9% to 22.8%, and therefore only attractive on best indicated terms for investors," the analysts wrote in a research note.

"We opine that the heightened risk aversion currently in the convertible market should be somewhat mitigated by the ability to hedge the credit and equity risk on the new bond," they wrote.

Barclays' credit spread assumption was based on Posco three-year CDS indicated at 100 bps. Although it will probably be slightly wider than this on renewed demand, at around 110-120 bps, the researchers said.

Also, Posco has $300 million of straight bonds due August 2016. Pricing appears to indicate a mid-price of 96.5, which implies an eight-year z-spread of 185 bps.

CDS at the same maturity was indicated at around 110 bps, which was assumed would now be nearer to 120 bps to 130 bps.

"Hence, we note about 60 bps of cash-CDS basis on the name, with the caveat that these indicated levels may not be reliable. At the shorter, three-year tenor (to the put) of the new exchangeable, we believe the basis would be narrower, and therefore take 150 bps as our spread assumption for modeling," the analysts wrote.

For the volatility, the SK Telecom ADS 100-day and 260-day realized volatilities in yen are currently 33% and 38%, respectively.

Interestingly, these are somewhat higher than the same volatilities in dollars, which are 28% and 32%, respectively. The differential has been fairly consistent over the past year. Also, 260-day volatility in yen is at a multi-year high, having risen from the low-20s during the past year.

Approximately at-the-money listed options on the ADSs do not appear to be highly liquid but are indicated with bid-implied volatilities around the mid 20s for early 2009 expiries.

"Taken together, we pencil in a fair volatility estimate of 23%. We see little risk of strike-pinning, as the bond would exchange into about 13 days of average daily volume. Given that the bond offers full dividend protection we use 0% for our dividend assumption," the analysts said.

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