Carlyle Exit Spells 20% Gain for Covalent Bonds on Trigger

Bondholders of Covalent Materials Corp. stand to reap a return of at least 20 percent if Carlyle Group LP and other investors sell the Japanese semiconductor-parts maker this year.

Carlyle and Tokyo-based Unison Capital Inc. are seeking to offload their stakes for about 50 billion yen ($491 million) by Dec. 31, people familiar said on May 2. According to Covalent’s debt covenants, a change of control occurs when the duo’s interests drop below two-thirds of voting shares. When that happens, bondholders can demand repayment of the notes at 103.75 percent of face value before Aug. 18, or 105 percent thereafter through Feb. 18, 2015.

Covalent’s 4.25 percent bonds due February 2017 were trading at 86.84 yen on May 14, having gained 3.8 percent this year, according to data compiled by Bloomberg. Local yen-denominated corporate securities are up 0.6 percent, Bank of America Merrill Lynch indexes show. Covalent’s notes, sold at par in 2008, fell below 70 yen in late 2009 following the global financial crisis.

“Whoever buys Covalent will have to assume bondholders will exercise the put option and demand repayment,” Taketoshi Tsuchiya, a senior executive in Mizuho Securities Co.’s fixed-income group in Tokyo, said by phone on May 9. “They’ll need to prepare to finance this at the same time because it’s clear from Covalent’s accounts it doesn’t have enough cash.”

Windfall Gain

A Tokyo-based spokesman for Covalent declined to comment on the private equity firms’ plans or on whether the company has enough money to repay the 25.3 billion yen of bonds. He didn’t want to be identified, citing internal policy.

Covalent, formerly known as Toshiba Ceramics Co., had 4.67 billion yen of cash and deposits as of Sept. 30, down from 5.74 billion yen on March 31, 2013 and 28.8 billion yen on Sept. 30, 2012, data on its website show.

Carlyle and Unison Capital hold a combined stake of about 94 percent, according to Covalent financial statements. Tammy Li, a spokeswoman for Carlyle in Hong Kong, declined to comment in a May 12 e-mail. Unison Capital also declined to comment.

An outright sale by the pair will trigger a change of control in Covalent, said Tsuchiya, who oversees credit trading at Mizuho. At either one of the next two put-option prices, bondholders stand to receive a windfall between 20.5 percent and 24.4 percent before tax, based on the notes’ current market price.

‘Good Investment’

Covalent makes materials and parts necessary for the production of semiconductors, such as quartz glass, silicon carbide products and ceramics, according to its website. It also makes medical products such as artificial bone filler.

The company had a net income of 5.3 billion yen in the year to March 31, 2013, accounts on its website show. It suffered a 34.1 billion yen loss in 2012, according to Bloomberg-compiled data. Earnings rose 12 percent to 1.64 billion yen in the six months to Sept. 30, 2013.

Buying into Covalent’s notes was “a good investment,” said Toshio Yoshida, a bond trader in Tokyo at Kyokuto Securities Co. which owns 2.4 percent of the debt. “We think the business environment has improved.”

Washington-based Carlyle and Unison Capital, a fund led by former Goldman Sachs Group Inc. bankers, bought Toshiba Ceramics in 2006 following a management buyout and delisted it from the Tokyo Stock Exchange in March 2007.

The renamed Covalent raised 55 billion yen selling five-year notes in February 2008 to repay debt, according to data compiled by Bloomberg. The transaction was arranged by Goldman Sachs and Mizuho.

Money Back

As semiconductor prices slumped in 2012, Covalent sold assets to raise cash and warned there wouldn’t be enough money to repay bondholders. Japan Credit Rating Agency Ltd. downgraded its notes to junk in April of that year and again in June to a level that signaled the possibility of a default. The notes’ price plunged as low as 61.47 yen in July 2012.

During a debt restructuring in October 2012, Covalent bought back 28 billion yen of its notes at 76 percent of face value, and extended their maturity to February 2017.

Covalent as a company may sell for about 48 billion yen in “the most optimistic valuation,” based on a multiple eight times its 6 billion yen of Ebitda, or earnings before interest, tax, depreciation and amortization, according to Tsuchiya.

“It’s almost certain bondholders will choose to exercise and will want their money back because the redemption price is much higher than the current market price,” Tsuchiya said. “But if the buyers don’t prepare the bond funding, the sale won’t make any sense, or succeed.”