For “the Netflix of China”, an initial public offering in New York was just a curtainraiser.
In the 12 months following the $2.4bn IPO of iQiyi, the Chinese video-streaming platform sold equity-linked financial instruments known as convertible bonds for more than three quarters of that amount. And it is not the only one.
Cash-hungry Chinese technology companies have turned to the convertible bond markets with gusto in 2019, raising $4.6bn in the year to date, according to data from Dealogic — many of them less than a year out from their IPOs. That is more than most years see in total and, unlike a convertibles rally for US tech companies that faded late last year, after offerings from the likes of Tesla and Twitter, analysts say this one may only get hotter as the year goes on.
Not all of the deals will pay off for investors, of course. The China convertibles market has grown so rapidly — as recently as 2012, total issuance from tech companies was less than $200m — that it has not been tested by a serious downturn. For now, though, “there is a new type of issuance in town”, says Aaron Arth, head of Goldman Sachs’ financing group in Asia ex-Japan. “High-growth tech businesses have been accessing the convertible market at a record pace.”
Convertible bonds grant investors the right to swap interest-paying debt for equity if a company’s shares rise to a pre-determined price. Investors typically get a lower coupon on the convertibles than regular bonds, in exchange for that option to own stock down the line. The appeal for issuers, including fast-growing, lossmaking tech companies with irregular cash flows, is that they can raise money more cheaply than straight debt, and without immediately diluting shareholders’ equity.
That prospect is especially attractive for Chinese tech companies that raised less than expected from selling shares, or which need to maintain rapid growth to stay competitive. Electric car start-up Nio, for example, which raised just over half its target of $1.8bn in a New York IPO in September, brought in another $650m with a convertible bond less than four months later. In March, iQiyi issued a $1.2bn convertible, the second within a year of its New York listing.
Asian companies have been steady issuers of convertibles, a technique pioneered in 1843 by New York and Erie Railroad, for a while. But Saurabh Dinakar, a managing director at Morgan Stanley in Hong Kong, said it was only in the past year and a half that Chinese tech companies listed in New York using American depositary receipts no longer had to pay as high a “China premium” when issuing convertibles.
“China ADRs have become much more well understood, investor familiarity has grown and as a result the China premium has contracted,” said Mr Dinakar. “This means the terms these companies are able to achieve are much more attractive.”
Another key factor is that the market capitalisation of some issuers has risen to a few billion dollars or more, said Luke Olsen, investment director at Aberdeen Standard Investments. “It means the size of [convertible] bond that they can issue is meaningful for global investors to get them interested, but it’s also meaningful for the company because they can achieve real growth capital,” he said.
All of this has coincided with a return of broader conditions that favour issuance. The US Federal Reserve’s dovish turn in March has prevented interest rates on bonds from rising higher, capping issuers’ cost of borrowing. This year China tech companies’ share of total issuance across Asia excluding Japan has climbed to more than 15 per cent as of the end of April, up from less than 7 per cent for all of 2018, according to Dealogic data.
On top of that, convertibles maturing later in the year may also give the China tech rally added staying power. (Investors in bonds coming due tend to sell shares they have been granted to book an immediate gain.)
“There’s a lot of money coming back into the system,” said Karen Pang, head of equity-linked debt origination for Asia at Deutsche Bank. That includes a so-called mandatory convertible from SoftBank of $6.6bn that is scheduled to convert into Alibaba shares held by the Japanese conglomerate in the middle of this year.
For the many investors who will be looking to plough cash back into the market, she said, Chinese tech debt should be the “natural choice”. That could help this year’s rally last longer than that seen for US tech convertibles in 2018, which fizzled out as fatigue set in among convertibles investors, Ms Pang said.
Mr Olsen is likewise optimistic about the outlook for Chinese tech convertibles in 2019 but cautioned that “this pace of growth isn’t necessarily going to endure for the next five to 10 years”.
“But in times of real market crisis, and you got a taste of this in the fourth quarter, it is important to see there is still a market for convertibles,” he said. “They are still active and the investors have a long-term incentive to ride out the natural volatility as they have a multiyear option on the equity.”