Korean Inc. issues perpetual bonds to improve financial structure

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Listed companies in South Korea are issuing new capital securities with perpetual bond features to improve their financial structures. The securities are recognized as equity for accounting purposes, making it easier to manage debt ratios temporarily but there are concerns about high interest costs and risk of worsening financial structures if conversion operations are not executed.

According to securities industry sources on Monday, Pulmuone Co. has successfully issued 30-year convertible bonds (CBs) earlier this month. A consortium, consisting of UAMCO Co., Kiwoom Private Equity Inc., and Highland Equity Partners Co., established “Lohas Private Equity Investment Joint Venture” to acquire the CBs issued by Pulmuone worth 100 billion won ($75.92 million).

The maturity yield of the CBs was set at 8~9.5 percent. They also include a step-up clause, which adds an annual 2.5 percent interest rate increment every five years after the issuance.

New capital securities, such as perpetual CBs, are hybrid bonds that are halfway between stocks and bonds. They are considered perpetual bonds as they have a fixed maturity but can be extended at the issuer’s discretion. Due to this characteristic, they are recognized as equity rather than debt for accounting purposes and are considered a way to raise funds while reducing the financial burden on the issuer.

Pulmuone is expected to use the proceeds to repay existing new capital loans and loans from affiliated companies. The company is said to have sought external financing as its liquidity shrank after it injected a large amount of funds by exercising the early redemption right (call option) of new capital securities and new capital loans worth 80 billion won at the beginning of the year.

Securities analysts have pointed out that Pulmuone’s successive conversion operations of perpetual bonds could potentially put pressure on its stock price.

“If all the CBs are exercised in the future, it will increase the number of shares by 20.7 percent, putting pressure on the company’s valuation,” said Han Yoo-jung, an analyst at Hanwha Investment & Securities Co.

Hyosung Chemical Corp. also decided last month to issue 70 billion won worth of bond-type new capital stock. The bonds have a maturity of 30 years, with an initial annual interest rate of 8.3 percent.

The issuance is reportedly intended to raise funds to repay corporate bills reaching maturity last month and in September, totaling 40 billion won and 100 billion won, respectively.

The new perpetual bonds will have a step-up clause applied after two years, increasing the interest rate by 3.5 percent for the first three years, 4.5 percent for the next five years, and 5.5 percent from then until maturity. If not redeemed prematurely, the interest rate could rise to the mid-13 percent range, posing a significant burden.

Some analysts believe that Hyosung Chemical was forced to issue the bonds due to its deteriorating financial health, with its debt ratio soaring to the 8,900 percent range in the first half of this year.

Small and mid-sized companies listed on the secondary Kosdaq are also choosing perpetual bonds as a means to secure operating funds without diluting their ownership stakes.

[Courtesy of Hana Micron]

In March, Hana Micron Inc., a semiconductor packaging and testing specialist, issued 48 billion won worth of 30-year convertible bonds. In July, ITM Semiconductor Co. issued 21.5 billion won worth of perpetual exchangeable bonds (EBs) to local securities firms and institutional investors, becoming the first Kosdaq-listed company to issue perpetual EBs.

The target of the perpetual EBs is the company’s treasury stock. The company is said to have issued the perpetual bonds to secure operating funds and funds for research and development for new products following a significant increase in orders in the second half of this year.

Nine Tech Co, a battery process equipment company, also raised 16 billion won through perpetual CBs last month.

There are some concerns over issuing CBs as the risk of conversion by companies has been highlighted after the call option debacle at Heungkuk Life Insurance Co. last year.

In the Korean capital market, it is almost taken for granted for perpetual bond issuers to exercise the call option on the mid-term redemption date, and the market impact could be severe if they do not execute it.

When the issuer raises funds by issuing perpetual bonds instead of regular corporate bonds, its financial structure remains intact, but there is a risk that its actual financial condition may not improve.

Additionally, if perpetual bonds are prematurely redeemed through the issuance of regular corporate bonds, the issuer‘s financial structure could deteriorate rapidly.

“Perpetual bonds are riskier than regular corporate bonds, and there is a risk that the issuer’s financial structure may deteriorate when the perpetual bonds are prematurely redeemed,” said a source from the asset management industry. “Due to the recent difficulties in the corporate business environment, companies that have financed conventional perpetual bonds also need to be cautious.”