Clever clogs

Temasek, the Singaporean state fund, sold S$650 million ($512 million) of bonds exchangeable into shares of Standard Chartered, the UK bank. Temasek owns an 18 percent stake in StanChart, and if the bonds were exchanged in full, its shareholding would fall to 17.2 percent.

The bonds pay no coupon, and were not issued at a discount to face value, giving them a yield of zero. They can be exchanged into StanChart stock at a 27 percent premium to its closing price on Oct. 17 of 1429 pence, implying a strike price of 1814 pence. The shares’ 52-week high is 1975 pence.

Shares in StanChart dropped almost 3 percent on Oct. 18, after details of the bond were announced. At 0830 GMT on Oct. 19 they were trading at 1402 pence, up 12 pence.

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Clever clogs
Temasek's StanChart bond looks too clever by half
19 October 2011 | By John Foley

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Temasek appears to have hit on an ingenious way of raising money cheaply. The Singaporean fund has sold S$650 million ($512 million) of bonds, exchangeable into Standard Chartered stock. If the emerging market lender’s shares rise more than 27 percent within three years, holders of the bond can convert at a profit. If not, bondholders get back exactly what they put in, with no interest. The wheeze may be a bit too clever.

At first glance, investors in the bond look to be getting a good deal. Imagine it as two different bits of paper, exchangeable into a single StanChart share. One part would be a zero-yield bond, with a face value of S$36. Assume lenders to triple-A rated Temasek normally demand a 1.8 percent annual return, and the bond is worth around S$34.50 today.

The other part is a call option on StanChart shares. Plug the lender’s current price, its forecast 3.5 percent dividend yield, and the implied volatility of StanChart’s stock into an options calculator, and it looks to be worth S$4.50. Put together, the two bits of paper have a total value of S$39 – some 8 percent more than investors paid.

But it’s probably not such a sweet deal. The value of the call option is inflated because StanChart’s shares are twice as volatile as they were before the summer. If the shares return to their steadier state, the option is worth closer to S$1, leaving the value of the whole package a little below the sticker price.

For Temasek, there are obvious attractions. Even if all the bonds are exchanged for shares, it will retain a 17 percent stake in StanChart. And if the shares don’t rise much, the Singaporeans will have borrowed S$650 million interest free.

But for all that, the savings are small. Say Temasek had simply borrowed directly from the bond markets. Over three years, its total interest bill would be less than S$40 million. Moreover, the bond issue triggered a mini-rout in StanChart shares, leaving Temasek with a paper loss on its remaining stake 10 times the size of the interest costs it saved. Other than demonstrating its financial prowess, Temasek doesn’t have much to show for its wizardry.