Sales of hybrid securities in South Korea have tripled this year as companies including Lotte Shopping Co. and SK Telecom sought to stave off debt-rating downgrades with stronger balance sheets.
Total issuance of the securities that have components or conditions that allow them to be treated as equity for accounting purposes surged to 2.38 trillion won ($2.24 billion) this year from 675 billion won in 2012, according to Bloomberg data that excludes financial companies. Lotte Shopping, whose ratings Moody’s Investors Service and Fitch Ratings Ltd. warned could be downgraded, raised 270 billion won with its inaugural sale of hybrids earlier this month.
Balance sheets are under pressure after borrowing by publicly traded companies surged 50 percent to the equivalent of $602 billion amid suppressed rates in the wake of the 2008 global financial crisis. The country’s firms issued $192 billion worth of bonds scheduled to mature in 2014, the most since 2010, with $183 billion still outstanding, Bloomberg data show.
“For top-rated companies, selling hybrid securities is a good tool for increasing equity without diluting shareholders’ rights,” said Jeong Dae Ho, credit analyst at KB Investment & Securities Co. in Seoul. “While long-term investors such as insurers do have an appetite for higher-yielding bonds with longer maturities, it may not be easy to attract other investors because hybrid securities aren’t nearly as tradeable.”
The surge in borrowing coincided with a jump in mergers and acquisitions by South Korean firms, with announced deals hitting a record $52.1 billion in 2012, according to data compiled by Bloomberg. Lotte Shopping’s 1.25 trillion won takeover of Lotte Himart Co. was the fifth-biggest deal of the year and the fourth-largest retail acquisition since 2000, the data show.
SK Telecom, South Korea’s No. 1 mobile-phone operator, faced its rating cut after its 3.4 trillion won takeover of SK Hynix Inc., which was the company’s biggest purchase, the data show. Total liabilities of the company surged to 9.87 trillion won as of 2012 from 8.55 trillion won in 2011. Moody’s, Fitch and Standard & Poor’s downgraded its creditworthiness immediately after the acquisition, which was more than 50 percent-funded by debt.
Posco (005490), the formerly state-owned steelmaker, was downgraded by Moody’s on Nov. 25. The company announced $7.6 billion worth of deals since the start of 2011, including its A$1.5 billion acquisition of Roy Hill Holdings Ltd. from Gina Rinehart, Australia’s richest woman.
While Standard & Poor’s Rating Services affirmed Posco’s BBB+ long-term rating in May, the company’s outlook was revised to negative because of its high debt and cash-flow concerns. Posco, whose net income dropped 44 percent from 2009 through 2012, sold 1 trillion won of hybrids in June while Posco Energy Corp. issued 500 billion won of hybrids in August.
“We believe Posco’s continuing non-debt financing, increasing sales volume and declining capital investment are likely to improve its credit quality and keep measures of its performance below our rating downgrade trigger next year,” S&P analysts led by Sangyun Han wrote in a May 30 report.
The specter of downgrades for some of South Korea’s most well-known companies comes even as momentum in Asia’s fourth-biggest economy is poised to accelerate to the fastest since 2010.
The improvement is being led by Seoul, mid and southwest areas of the country, the Bank of Korea said in a quarterly “Golden Book” report released Nov. 27 in Seoul. The central bank on Oct. 10 projected 2.8 percent growth this year and 3.8 percent growth next year, the fastest since 2010, when the economy expanded 6.3 percent as it pulled out of a global downturn.
The BOK warned the appreciation of the won threatens to damp exporters’ profit as the currency hit its highest level versus Japan’s yen in five years. The won reached 10.374 per yen yesterday, the strongest since September 2008, and traded at 1,061.35 against the U.S. dollar in Seoul.
Lotte Shopping’s third-quarter operating profit was 342.8 billion won, the company said on Nov. 8. That compared with the 357.7 billion won average estimate of analysts surveyed by Bloomberg.
“The recent sluggish operating performance, high investments and increased rental expenses have put further pressure on Lotte’s credit metrics,” Fitch analysts led by Jeong Min Pak wrote in a Nov. 26 note reiterating the retailer’s BBB+ with negative outlook rating. The use of the hybrids “will have a positive impact on the company’s balance sheet and net leverage ratio.”
The 30-year hybrid bonds sold by Lotte Shopping yield a fixed-rate of 4.723 percent for the first five years, which is 150 basis points more than the similar-maturity of government bonds, data compiled by Bloomberg. That compares with 39 basis points of premium for average five year similarly-rated corporate bonds. The yield on the 10-year government bond is little changed this week at 3.67 percent.
Lotte has a right to buy back the hybrids after five years, when the yield will be reset according to the rate on government bonds at that time. If the company doesn’t purchase them after 10 years, it has to offer 100 basis points more than the existing fixed rate.
“We expect to receive a favorable assessment from global rating agencies because 50 percent of the securities can be considered as equity,” Lee Jin Hyo, a spokesman for Lotte Shopping said by phone on Nov. 26. “The issue size of 270 billion won was probably as much as the market could accept as Posco and SK Telecom sold a considerable amount of hybrids previously.”
South Korea’s Accounting Standards Board formed a conclusion on Sept. 30 that the securities are classified as equity, according to a statement from its website. Still, rating agencies give the securities only partial equity treatment for determining creditworthiness.
“It’s hard to price hybrid bonds as their structure isn’t familiar to investors,” said Kim Sang Man, credit analyst at Hana Daetoo Securities Co. in Seoul. “Investors may hesitate to buy such longer-dated bonds as interest rates are expected to rise in the long run. However, demand for selling hybrids will remain because top-rated companies, facing ratings cuts, need to improve their finances.”
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