China official PMI hits 16-month high in August

The purchasing managers' index (PMI) figure, published by the National Bureau of Statistics, rose to 51.0 in August from 50.3 in July, the highest level since last April and ahead of market expectations of 50.6 in a Reuters poll.

New issue highlight

Hankore Environment Tech Group Limited (?Hankore?) this morning announced a

proposed 2-year S$-denominated HY issue, with initial price guidance at the 7.5%

area. The bond has the following structural features: 1) A COC put at 101 should

the Chairman cease to be the largest shareholder of the company 2) An interest

reserve account containing 1 semi-annual interest payment, to be prefunded at least

3 months prior to interest payment date and 3) Financial covenants ? consolidated

tangible net worth of at least RMB1.2bn, consolidated net borrowings to

consolidated tangible net worth of < =1.5:1 and consolidated secured

debt/consolidated total assets < =0.5:1. The expected use of proceeds will be for

general corporate purposes. Currently, the order books are in excess of S$50mn.

New issue view

Despite the improving operating trajectory of the company post-restructuring and a

modest capital structure under a predominantly new management team, we retain

some concerns about residual corporate governance issues, given the haircut taken

by CB investors during the debt restructuring in 2010 and 2011. At the price

guidance of 7.5%, the 73bp premium over the CENCHI?16 (indicated at 109.7

offer/6.77%YTM) does not seem to be sufficient, given: 1) Its past corporate history

2) Lack of strong parentage 3) Weaker covenants relative to CENCHI and 4) The

proposed bond offering is its debut issuance in the SGD HY market post

restructuring.

The key risk to our view is the potential for the bond issue to print, given the high

yield on offer for a relatively short duration paper, a generous PB rebate and the

recent pick-up in SGD high yield new issuance.

Background

Hankore Environment Tech Group Limited (?Hankore?) is an urban environmental resources

recycling solutions provider, with a core focus on wastewater treatment, water recycling, water

supply, sludge treatment, investment in and financing of projects in the water treatment industry,

equipment manufacturing, construction engineering and operation of related projects. With a

portfolio of 10 BOT projects and 1 TOT project, Hankore?s main source of revenue consist of

water tariffs (70.3% of FY2012 revenues), with the remainder from BOT construction services.

The company?s key shareholder is Mr Chen Dawei, David, with a beneficial interest of 17.54%

as of 19th July 2013 through his investment vehicle Giant Delight Holdings. Other major

shareholders include Total Summit Technology Limited (7.95%), Firstree Group Limited

(7.47%). Firstree is a company wholly-owned by Mr Wang Ting, who is the Chairman of China

Mainland De Zhou Investment Fund. Pending the completion of a proposed equity placement,

Mr Wang Yu Hwei is also slated to be a substantial shareholder through his investment vehicle

Asdew Acquisitions Pte Ltd.

Prior to the debt restructuring in December 2009, Hankore was known as Bio-Treat Technology

Limited, incorporated in Bermuda in 2003 and listed on the SGX in 2004. Post-restructuring, the

key executive management of Hankore was Mr Chen Dawei (Executive Chairman) and Mr Nie

Jian Sheng (CEO). Mr Chen Dawei was previously the CEO of China Media Development

Group?s China operations and sat on the board of Beijing Jun Tai Investment Management Co.

Ltd. He is also the founder and CEO of Beijing Revolution Science and Technology Co. Ltd, with

over 8 years of direct experience in the wastewater treatment industry. Mr Nie Jiansheng served

in various senior management positions in Hongkong-based companies such as Tianjin

Development Holdings Ltd, Dynasty Fine Wines Group Ltd and Tsinlien Group.

As of 25th July 2013, Hankore has a market capitalization of S$249mn.

Key credit considerations

▪ Past history of debt restructuring: After defaulting on a put on its S$145.6mn CB in 2008,

Bio-Treat (predecessor company of Hankore) settled on its obligations in December 2010 at

the low 20 cents on the dollar after a c.S$40mn rights issue. In mid-2011, a HK$360mn

shareholder loan previously used to cover part of the CB redemption payment in 2010 was

restructured from the proceeds of another equity issue even though this shareholder loan

was controversial ? despite theoretically being more junior in the capital structure, all the

company assets were pledged as collateral for this facility, granting it de facto seniority over

the defaulted CBs.

▪ Exposure to interest rate and FX risks: Hankore?s debt is 100% based on floating rates,

exposing it to the risk of a steepening yield curve since it does not hedge. Also, it does not

hedge its FX risks (primarily RMB revenues against S$ and HK$ debt) as it relies on natural

hedging from its revenue/cost base.

▪ Potential equity raising is credit positive: On 18th July 2013, Hankore announced that it

has entered into a share placement agreement with Wang Yu Huei, a Singapore

businessman. Under the terms of the agreement, Mr Wang will inject S$14.68mn in net

proceeds into Hankore and be a substantial shareholder in the company with a beneficial

interest of 6.09% of the enlarged issued and paid-up capital of the company. The transaction

is currently pending regulatory review. Should this transaction be successful, the liquidity

position will improve with pro-forma cash of RMB140.8mn (up from c.RMB70mn as of end-

March 2013) while adjusted gross debt/total capitalization will decline by 80bp to 25.6%.

▪ Credit metrics are modest: While Hankore has exhibited reasonably good margins and

moderate leverage metrics as it steadily increases its equity base, on an annualized

9MFY2013 gross debt/EBITDA basis, it is still elevated at 5.8x. Interest coverage ratios

seemed adequate with EBITDA/gross interest and FFO/gross interest of 2.2x and 2.4x

respectively. While 9MFY2013 FCF is positive, this was mainly driven by a material reduction

in capex rather than an increase in CFO (estimated to be flat to FY2012 levels). With still

significant working capital demands for construction work and prepayments for Hankore?s

expansion and upgrading works, we do not expect CFO to improve materially in the near-

term.

▪ Near-term debt reduction is unlikely: End-March 2013 cash balance of RMB69.7mn is

insufficient to repay RMB151.9mn of short-term debt due within the year and even after

accounting for the net proceeds raised from the proposed equity issue, is still slightly less

than 1x coverage of short-term debt, necessitating refinancing. For Hankore to achieve

escape velocity for its restructured operations, we believe that further equity infusions are

necessary, if not more debt. Hence, deleveraging is unlikely.

Bond structure

Despite the inclusion of the interest reserve account (1 semi-annual interest payment and the

need for prefunding 3 months prior to interest payment date) and the financial covenants, the

formulation of the indenture is still materially weaker than what is normal for a typical HY issuer.

There are no covenants for key areas such as limitations on indebtedness, restricted payments,

mergers and affiliate transactions.

As a matter of practicality, potential enforcement of bondholder rights is difficult since the issuer

is domiciled in Bermuda despite being listed on the SGX. Furthermore, the issuer does not have

material operations of its own but is dependent on dividend upstreaming from onshore PRC

Opcos to service its debt, none of which guarantee the proposed bond.

▪ Structural subordination risk: Hankore is a company domiciled in Bermuda and listed on

the SGX. As an investment holding company, it does not have material operations and

controls its key operating companies (?Opcos?) in the PRC through various offshore holding

companies (?Holdcos?). As the PRC Opcos do not guarantee the obligations under the

proposed bond, bondholders are subject to subordination risk arising from the incurrence of

onshore senior debt at the Opcos? level.

▪ Change of control (?COC?) covenant is weak: The COC covenant is weak as it does not

contain a ?sale of all/substantially all assets? trigger which is typically enshrined in a HY bond

indenture. We consider this a significant risk as Hankore is reported to be in discussions with

potential interested parties in acquiring a portion or all of its water treatment assets. To the

extent that these sales go through, bondholders are not protected as the cashflows from the

water treatment assets may no longer support debt service on the bond and yet, they are not

able to put the proposed bond back to Hankore. Furthermore, a merger with another public

company with a dispersed shareholder base will also not trigger the put, which is a

weakness.

▪ Inclusion of financial covenants is a strength: While not unusual for SGD HY issues, the

inclusion of financial covenants is a strength for bondholders. The formulation of these

covenants is slightly different from what is typically seen for USD issues which is based on a

fixed charge coverage ratio (i.e. an EBITDA/interest metric).

▪ Limitation on asset sales covenant is weak: While this covenant is in the indenture, the

scope of this is fairly limited and unlike the typical regime for HY issuers since any asset

sales is allowed as long as it is incurred in the ordinary course of business.

▪ Dividend covenant: This covenant prohibits Hankore from making any dividend payment,

capital reduction or other shareholder distributions as long as principal and/or interest

payments are outstanding or if there is a breach of covenants under the indenture. Since

dividends have been nil over the past few years, we see limited utility in this covenant.

▪ No optional redemption prior to maturity other than upon the occurrence of specified

events: The bonds are not payable prior to maturity other than for tax reasons, in the event

of a listing or if there has been an asset disposal to a trust which is not more than 50%-

controlled by Hankore.