Private placements in Asia
Tens of billions of dollars in financing arrangements are in trouble
ASIA may be the bounciest part of the world economy, but many investors in the region are feeling decidedly deflated. The source of their misery is the private-placement market, which offered great riches before the crisis but now provides little protection after it. The scale of the mess is unclear but a rare window into one of these transactions opened in May when half a dozen Western hedge and private-equity funds were named in various legal actions filed in London and Jakarta by shareholders of CP Prima, a large Indonesian agricultural company.
In 2007 the funds provided $200m to finance CP Prima's consolidation of the region's shrimp-farming operations. The financial crisis and a devastating virus sent CP Prima's share price spiralling downward. The firm's controlling shareholders are now demanding billions of dollars in damages from its bondholders for taking control of a Singaporean special-purpose vehicle called Red Dragon that had been used as a conduit for the loans.
Many more of these kinds of conduit deals are under pressure as companies flail and investors debate whether to restructure their debts. Insiders reckon that at least 100 such placements were done for Chinese companies, another 50 for companies in Indonesia and a smattering more for companies in Thailand, the Philippines and Malaysia. Tom Wadham of Debtwire, a news service, says the relatively firm data on $7 billion-worth of transactions his firm has tracked constitutes only the most high-profile and broadly syndicated deals. He believes the size of the market must be in the tens of billions of dollars, and that more than 90% of transactions are probably now in deep trouble.
The roots of the current mess date back to 2005 when Asia's boom attracted many Western hedge and private-equity funds. They soon discovered there was little that could be purchased on public markets and even less, given the amount of money flooding the market, that could provide a substantial return. At the same time local companies were eager to raise money for capital investment but faced bureaucratic impediments to issuing public securities. This was particularly true in China, where every public offering of debt or equity requires not only a government endorsement of a company's specific plans but also a long wait in a queue to raise money. Other Asian countries were a bit easier.
As a result, financing structures were developed that typically used an investment entity in another location—usually Singapore, Hong Kong, the Cayman Islands or the British Virgin Islands—that could receive money and then pass it on to the operating entities, wherever they might be. Avoiding a direct tie between investors and the investment cut out the local regulators. But it also meant creditors had no security interest in the companies themselves and little protection in the event of a default.
In exchange for these risks there was the prospect of great returns. In the case of CP Prima, investors in the Red Dragon vehicle could swap the bonds for shares at a steep discount after three years. If CP Prima's share value was merely stable, the annualised return would exceed 14%, a huge return at the time.
A similar structure was widely used by companies that planned to go public in the near future: a low-yielding convertible bond would be issued that could be swapped for cheaply priced shares prior to an initial public offering (IPO). For the global investment banks that arranged these deals, it was all hugely lucrative. They received fees of up to 8% for a private placement and could expect another 2% in fees in the likely event of an IPO.
The crisis leaves many hedge funds and private-equity firms sitting on heavy losses. The question now is where the red ink is hiding. One theory is that some write-offs have already been buried in the welter of losses taken during the crisis. Another theory is that these investments, being both private and illiquid, have yet to be marked down. If so, the hope is that a recovery, and the incentive firms have to keep relations with creditors cordial so they can raise money in the future, will offer a hidden rescue to a silent disaster.