Published February 23, 2009

'Toxic' notes make return

Credit squeeze is forcing firms to issue convertible bonds at discount

By CHEW XIANG

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'TOXIC' convertible bonds are reappearing here for the first time since the credit crisis hit, as small firms struggle to get cash from more benign partners.

One fund, Fortensa Special Opportunities, is investing up to $40 million in zero-coupon convertible notes in TTL Holdings, the company revealed last week. Sources say Fortensa is backed by a group of American investors and was introduced to the company in the middle of last year by Harford Vantage, a local financial advisory firm.

TTL, which provides plastic products to the electronics industry, has a market capitalisation of just $28.3 million, based on its last-traded price of 11.5 cents a share. It is being sued by a supplier in China and recently recorded a net loss of $1 million for the half-year to December, although it holds cash of about $6.5 million.

One industry source says that zero-coupon convertibles are seen as the last resort for companies in need of cash. 'If they have any other option, they will be taking it instead,' the source said, noting that banks and other traditional sources of funding are still unwilling to lend, especially to companies perceived to be more risky.

The TTL notes, in 40 tranches of $1 million each, can be converted to shares at a 10 per cent discount to the market price, rather than at a premium as is normal.

Such 'toxic' notes that convert to shares at a discount are notorious in the industry because each convert-and-sell cycle tends to erode the share price badly. They are also known as 'death-spiral' convertibles.

In some cases, a fund may even borrow shares from a substantial shareholder in the company to sell its stock short, before covering back using newly converted shares. Sources say Fortensa attempted to borrow shares as part of negotiations with TTL but was rebuffed.

When the instrument was in its heyday from 2006 to early last year, small companies here worth less than $100 million were issuing toxic bonds for $60 million to $150 million to funds such as Pacific Capital Investment Management, Value Capital Asset Management, the Cayman Islands-registered Advance Opportunities Fund and Delaware-registered DB Zwirn Asia Pacific Special Opportunities Fund.

But since mid-2008, new issues have come to a standstill and many existing ones have been cancelled, sometimes with the company paying substantial penalty fees to protect its share price from repeated attacks.

China Fashion, Guangzhao IFB Group, EMS Energy, Equation Corp, HLH Group, Anwell, Centillion Environment & Recycling, E3 Holdings and Dayen have all terminated deals, while Multistar Holdings had to pay $190,000 in cash last August to do so.

Fortensa has also, within the past two months, invested a total of $1.7 million in share issues of two other penny stocks, Adventus Holdings, formerly SNF Corp, and Enzer Corp, an electronics company that is now moving into property.

Enzer placed out 10.8 million shares - 9 per cent of the company - to Fortensa last December at six cents apiece. After this, its shares spiked, at one point to 16 cents, while volume has also surged. Fortensa sold much of its stake in the first half of last month and is no longer a substantial shareholder. Its last reported stake was just 3.75 per cent.

Adventus, meanwhile, is placing 14.3 million shares at seven cents apiece for a net $950,020, the company said on Jan 23. Just a week previously, it guided for a larger-than-expected net loss for the reporting period.

Adventus said that Fortensa was also introduced to it by Harford Vantage, the same firm that facilitated the investments in Enzer and TTL. Adventus executive director Khoo Gee Choo is a director and shareholder of Harford, but the company said that she took no part in the investment decision.

Vanilla share offerings are likely to be less attractive to funds such as Fortensa because of public disclosure requirements, but it has profited from flipping its Enzer investment nonetheless.