Alibaba (BABA.US) recently issued convertible senior notes (“CN” or “CB”) for share repurchase through a private offering, totaling US$5 billion (equivalent to approximately HK$39 billion), carrying a remarkably low coupon rate of 0.5% and a maturing in 2031. Despite the low yield, the offering experienced significant oversubscription, indicating strong demand from qualified institutional investors. In contrast, the 7-year U.S. Treasury bond yield was around 4.5% during the same period, highlighting a substantial difference in risk and return between U.S. Treasury Bond and Alibaba CB. This article delves into the factors that prompt investors to transition from risk-off high-yield assets, such as the U.S. Treasury bond, to risk-on low-yield assets, like Alibaba CB. It also explores the strategies of stock price hedging and provides insights into the current capital market environment in Hong Kong.
Share Price Hedging Strategy
Institutional investors frequently employ a strategy where they purchase CBs while simultaneously engaging in short selling of the underlying stocks. This approach allows them to benefit from rising stock prices by converting the CB into stocks when the market price exceeds the conversion price (In-the-Money). Conversely, if the stock price falls (Out-of-Money), short selling serves as a hedge to control downside risks and secure profits. As a result, it is common to observe a significant increase in short selling volume both before and after issuance of CB, potentially leading to a decline in the stock price. Furthermore, companies that issue CBs often repurchase short-sold shares at the same time, taking advantage of the lower prices and mitigating the impact on the stock price.
Current Capital Market Environment in Hong Kong
Hong Kong’s bankers and investment institutions have experienced a slowdown in large-scale M&A and initial public offerings (IPOs). In recent years, the IPO market in Hong Kong has diminished significantly, with only 27 listings raising HK$11.6 billion in the first half of 2024, as reported by KPMG. In contrast, Alibaba’s CB received HK$39 billion in the market within a short period. This highlights the appeal of CBs as an alternative way out of funds in the context of a sluggish capital market and the need for asset allocation. It is anticipated that investment bankers who are facing the unemployment wave will actively look for business sources beyond M&A and IPOs. This involves finding qualified buyers to sell undervalued listed companies’ CBs, even if they offer low yield returns.
Benefits of using CB for Share Buyback
Qualified buyers of CBs recognize several key benefits associated with using CB for repurchase. Firstly, Alibaba sold conversion options with a premium exercise price of 30% (between the last reported sale price of US$80.80 per ADS and the initial conversion price US$105.04 per ADS). This generated funds that can be used to repurchase undervalued shares, indirectly serving as a tool for value restoration and arbitrage. Secondly, as private offerings, qualified buyers typically already hold a stake and are willing to invest an additional US$5 billion in Alibaba. Concentration of their ownership occurs if the CBs are converted into shares, potentially resulting in a more effective boost in the stock price, rather than solely obtaining the 0.5% interest.
Risk is On Now?
Amidst the risk-off and risk-on investment strategies, the market is considering using funds to subscribe CBs for share buybacks. Investors are intrigued by the opportunity to profit from undervalued companies in an economic environment that has not fully recovered. This raises the question of whether this indicates a potential bottoming out of the stock market and whether it is time to embrace a “Risk-On”.
References:
Alibaba Group Announces Proposed Offering of Convertible Senior Notes
https://www.sec.gov/Archives/edgar/data/1577552/000119312524149515/d779816dex992.htm
Chinese Mainland and Hong Kong IPO Markets 2024 mid-year review (kpmg.com)