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Greed: Ever tighter pricing leaves bad aftertaste in secondary market for Japan’s converts

Too much of a good thing can often end up being less of a blessing and more of a curse, especially when the greed factor is worked into the equation.

And that’s approximately the case with Japanese convertible bonds (CBs), the darlings of investors in this hybrid asset class amid a drought of paper from elsewhere across Asia for pretty much all of 2023.

The second largest economy in Asia raised USD 3.75bn by offering 17 convertible notes last year as a result, almost 9x the previous year’s USD 431m, Dealogic data show.

Graphic comparing the number and volume of Japanese convertibles deals month by month from September 2022 to June 2024

Driving up demand for Japanese issuance were government guidelines for listed entities to better shareholder returns and improve corporate governance by unwinding cross-shareholdings, as well as putting hoards of idle cash to work, with a share price 1x the book value being a key parameter.

In general, issuers across the region were pretty disciplined in terms of deal valuations in 2023 in light of the challenges of betting on global rate direction.

JFE Holdings’ [TYO:5411] JPY 90bn (USD 613.8m) CB issued in September 2023 was even considered in the running as the most sought-after Asian equity-linked offering in six years, as reported at the time.

But change is in the air this year.

Increasingly Japanese issuers have been pushing harder on their terms, and that has left a bad taste in the mouth of the secondary market.

Market participants told this news service that while they haven’t seen deals badly mispriced, deal pricing has tightened over the course to make Japan’s notes as a group less palatable than they used to be.

For instance, prior to 2024, an offer price around 102-102.5 was the norm for most paper, including that of JFE Holdings’ notes.

This year, we have seen Ibiden’s [TYO:4062] JPY 70bn (USD 467m) Euroyen convertible bond offered at 107.5, though arguably the company is an AI-concept title. Ibiden is one of the few issued in 2024 that remains above water.

Aside from offer prices that keep inching higher, we have seen deals that are oversized compared to the issuer’s market capitalization, or issuer profiles that are so dull that some investors can’t be bothered about modeling.

The Japanese yen’s weakness has also dented confidence in holding Japanese assets, said a first market participant.

All these factors have weighed on secondary trading.

Daiwa House Industry‘s [TYO:1925] JPY 200bn (USD 1.38bn) dual-tranche convertible bond (CB), offered at 102.5 each tranche, traded around 96.50 and 97.52, respectively.

Japanese Sic power device manufacturer Rohm’s [TYO:6963] JPY 200bn (USD 1.3bn) jumbo dual-tranche offering traded at 101.56 and 100.49, respectively, both below the 102.5 offer price.

A pullback in the Nikkei 225 index from an all-time high hit in March has also somehow dampened investor interest in Japan assets as a whole.

“Some of these names are not providing enough volatility for hedge funds to trade either,” said a second participant.

A third participant also lamented that recent Japanese deals simply don’t leave much on the table for investors.

“I can’t think of any case that’s outrageous to me,” said a fourth participant, who has participated in almost all Japanese offers so far this year. But he acknowledged that a lot of the paper has been priced too tight — while not quite qualifying as “mispriced.”

Fukuyama Transporting Co [TYO:9075], which in March launched but swiftly canceled a JPY 30bn (USD 202.3m) CB offer, probably stands as the deal that was so off-the-mark it shouldn’t have happened at all. The deal was arranged by Nomura, based on an official announcement.

Issuers need to be aware that supplies will keep coming, and any overly aggressive pricing will have a daunting effect on secondary valuations in the entire universe.

“And your deal wouldn’t be making money either,” said a fifth participant.