Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Big Chinese companies are turning to the convertible bond market as a way of raising cheap cash from US hedge funds while circumventing investor concerns about political tensions between the two countries.
Traditional US equity fundraising routes such as initial public offerings and follow-on share sales have been almost completely shut to Chinese companies since the disastrous listing of rideshare group Didi in 2021, which delisted the following year after regulatory scrutiny.
In recent weeks, however, a string of large Chinese technology groups have raised billions of dollars through issuing convertible bonds. Such debt typically pays a lower coupon than conventional bonds, but can be converted into stock if a company’s valuation rises to a pre-agreed level.
Ecommerce groups Alibaba and JD.com and travel platform Trip.com have issued a combined $8.3bn worth of dollar-denominated convertibles over the past month, and analysts expect more companies to follow suit.
“It makes a lot of sense for these larger, megacap Chinese tech names,” said Michael Youngworth, a convertibles strategist at Bank of America. “I wouldn’t be surprised to see the trend continue.”
Companies are being encouraged by these bonds’ popularity with specialist hedge funds that can buy up the debt without worrying about political issues, say market insiders.
So-called convertible arbitrage managers try to make money by exploiting differences in the price and volatility of bonds compared with the corresponding equity. Traders hedge their bond purchases by shorting the company’s shares, giving them protection against overall market moves as well as against changes in the price of the bonds driven by company-specific news.
“It’s fair to say the Chinese converts are being priced for hedge fund buyers,” said a senior banker involved in one of the recent deals. “When a hedge fund buys this and puts a trade on, they’re playing with volatility and hedging it, they’re not taking a fundamental point of view.”
“As long as the [stock] that is listed in the US is liquid and available for borrow, then there will usually be that technical bid [demand] from the hedge funds, whether or not they have a fundamental view on the economy or [other] issues,” said Bryan Goldstein, an adviser at Matthews South who specialises in converts. “The megacap Chinese issuers fit that mould.”
Many hedge funds withdrew from the convertibles market after suffering large losses in the 2008 financial crisis when prices tumbled. But they have become more active in recent years, after issuance surged during the coronavirus pandemic when interest rates were cut to ultra-low levels. Convertible arbitrage funds have gained 5.1 per cent so far this year, according to data group HFR, after making 4.8 per cent last year.
BofA’s Youngworth estimated that such funds account for around two-thirds of bids on recent convertible deals. In some cases, they can make up almost the entire order book.
Matthews South’s Goldstein said foreign convertible issuers tended to be charged higher interest rates than an equivalent US company due to extra complexities, such as foreign exchange risk.
But the cash on offer is still much cheaper to raise and more freely available than it would be through traditional stock or bond markets.
Chinese companies have raised more than $75bn in US listings over the past decade, led by Alibaba’s bumper deal in 2014, according to Dealogic data. However, Didi’s botched IPO and broader concerns about geopolitical tensions have triggered a sharp drop-off in large deals.
Only one Chinese group has raised more than $100mn in a US IPO in the past three years — electric vehicle maker Zeekr, which raised $441mn last month.
With US interest rates held at a 23-year high this week, the low yield on converts is proving attractive to issuers.
Alibaba priced its convertible bond deal with a coupon of just 0.5 per cent, while JD and Trip achieved coupons of 0.25 per cent and 0.75 per cent, respectively. That compares with the average yield on dollar-denominated convertible bonds of 3.125 per cent, according to BofA’s Youngworth. The average US high-grade bond yield stood at around 5.4 per cent on Wednesday.
The recent deals by Chinese companies come amid a broader increase in convertible bond sales, with almost $41bn of new issuance so far this year, according to data from LSEG. That is the highest figure since 2021, during the borrowing frenzy in the pandemic.
“The cost of capital of the convert has become incredibly compelling [for issuers],” said the senior banker who worked on one of the recent Chinese deals. “We think it will be a major financing tool as long as interest rates stay up here — it might not be as sexy as the IPO market, but it’s a huge theme.”