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Don Quijote takes the road less travelled

01 Jun 2006

Since 2002, Credit Suisse has arranged three public capital markets deals for innovative retailer Don Quijote. EuroWeek talks to the bank and to Don Quijote management about their experiences.

Life for a fast growth retailer in Japan was not always as easy as it is today. Don Quijote first listed on Jasdaq in 1996 and moved to the second board of the Tokyo Stock Exchange in 1998. When Don Quijote moved to the first section of the TSE in July 2000, deflation and pessimism reigned supreme.

In those days, banks were struggling with their non-performing loans and reluctant to increase lending to any but the largest of Japan's corporations. Access to fresh capital for small to mid-sized capitalisation stocks was limited at best and in many cases impossible.

Nevertheless, Credit Suisse bankers had spotted in Don Quijote's management and business model a combination that they believed would win through in Japan's tough retailing world. They also expected that the country's economy and financial markets would eventually turn the corner and optimism would return.

Don Quijote is one of Japan's leading discount retailers by profitability, operating stores all over Japan. The company differentiates itself by designing the layout of its stores in the form of a jungle or maze and by offering the low price appeal of a discount store. Sales have grown 35% compound since 2001.

Tapping seams of investor demand

"We have worked closely with the company to provide innovative funding solutions and to promote their name with investors at home and abroad," says Andrew Brownfield, managing director and head of capital markets at Credit Suisse in Tokyo. "Our work with them is like a case study of the smart and effective use of the global capital markets for a mid-cap company."

The first transaction, in March of that year, was a simultaneous ¥8bn five year zero coupon convertible bond issue launched into the Euromarket and a ¥4.65bn share sale by the company's founder.

At the time Don Quijote was (and still is today) rated BBB by domestic rating agency JCR, a rating that probably translates to Ba3/BB- would Moody's and Standard & Poor's be applying their own ratings' standards.

Unusually, the convertible bonds carried what is called a 'knock-out' put option at December 2003 at par, as well as a put option at 102% at December 2004.

The 'knock-out' put option becomes non-exercisable if the share price trades above a certain threshold. "This new CB feature in Japan," explains Jiro Yasuda, director, equity capital markets, at Credit Suisse in Tokyo, "provided investors with a redemption opportunity in case the share price didn't perform, while Don Quijote benefited from an improved pricing of the convertible bond and an extension of the put maturity in case of share price performance."

Preparing for a second foray

Credit Suisse has not only worked on public transactions — it has also arranged regular investor roadshows for Don Quijote since November 2000, when the company visited investors in Europe.

"Regular non-deal roadshows for a company of this size help build investor familiarity and confidence, which has been vital, especially during Japan's long economic winter," says Brownfield.

The second foray into the Euromarket came in early 2004, when Credit Suisse, jointly with what was then Tokyo-Mitsubishi International, priced a ¥17bn zero coupon convertible bond.

This time the bonds carried much more appealing terms for the issuer, with a seven year term, a 15% premium and a negative cost of funds of 0.833% per annum, based on the 102.5% issue price and 100% redemption price at the three year put.

At that time, Don Quijote was valued at ¥120bn ($1.05bn) and the average daily trading volume of its stock was only about ¥300m ($2.6m).

The order book for the issue comprised more than 280 accounts, a testament to the work the arranger and issuer had done in promoting the name with investors since 2001.

Pioneering high yield issue

The last of the three public issues emerged early in 2005 when Credit Suisse sold what was a very rare high yield bond issue in the domestic public bond market in Japan.

The ¥15bn financing carried a maturity of three years and was priced with a coupon of 1.25% to yield yen Libor plus 90bp. Trust banks and asset management companies that were visited during the roadshow bought most of the bonds.

"There was then and still is virtually no high yield bond market in Japan, but we have sought to help create such a market in Japan, leveraging off our US and global expertise in this area," says Brownfield. "Then, as now, the lending market was dominated by the banks and it was refreshing to see a deal such as this provide the client with an attractive cost of funds, as well as investor diversification through disintermediation of the lenders."

What are the particular challenges you have faced in your funding activities as a fast growth small and then mid-capitalisation stock in recent years?

It is difficult for rating agencies and debt holders to fully understand our business strengths. We obtained a BBB rating first in July 2001 from a domestic agency, and while we have expanded our business tremendously since then, our rating has stayed the same.

On the other hand, it is easier to appeal to equity investors with our growth story, but at the same time partaking in the equity market requires substantial preparation and is easily influenced by prevailing market conditions.

We strongly believe our success in raising funds from the equity markets stems from our dedicated investor relations efforts.

When you entered the Euroyen convertible bond market in 2002, what alternatives were available to you and why did you opt for the ¥8bn convertible bond? Was it a success?

At the time, we were in a period of high growth and were seeking financing for our new store openings. In addition, we wanted to improve our equity capital base and therefore focused on equity financing.

A follow-on offering of primary shares was an option, but we wanted to avoid such immediate dilution and chose to issue a convertible bond, which was low cost financing and allowed shares to be issued at a premium.

Initially, the plan was to issue the bonds in the Swiss market. However, upon deciding simultaneously to sell shares held by our founder, we decided to issue the convertible in the Euromarket where there was access to a wider range of investors.

Through a convertible bond issue and secondary share offering in a difficult market, we were not only able to satisfy our financing needs but reduce our tax liability (tax on undistributed profits). We believe the offering was a great success, with our share price increasing 45% in the following three months.

What about the ¥17bn convertible bond issue of January 2004?

The situation was similar to that in 2002. We were aggressively opening new stores and we were confident of our future earnings. We were able to choose a convertible bond offering better terms than in 2002.

While interest rates were low at the time, it was extremely difficult for triple-B rated firms to issue a straight bond. When compared to 2002, we were not only able to issue with a zero coupon, a higher premium and longer maturity but also filled the book in a short period and priced the issue overnight. Our share price also increased 17% in the following three months.

What led you to issue the ¥15bn domestic high yield bonds last year?

We did not consider equity financing that would result in any dilution because we had issued a convertible bond a year earlier. Previously, we had conducted debt financing through bank loans and private bond issues, but we decided to go for a public straight bond offering to diversify our financing options.

We conducted a roadshow over a few days and received more investor demand than we expected, and we believe the offering was a success. We were also able to gain an edge in our negotiations regarding bank loans due to our public straight bond offering.

How did the cost of funds and maturity of the high yield bond issue compare with your funding alternatives at that time?

For a maturity of three years, it was slightly cheaper to issue a straight bond than take on bank loans. In addition, the longest bank loans are for one year, hence a three year term was a better long term financing alternative.

What other funding alternatives have you considered?

We began to securitise several properties (land and buildings), in September 2000 with our first East Shinjuku store, and currently have four such securitisations on eight stores. Securitisation, however, depends on the actual property and is not always a low cost solution.

We conducted two straight equity offerings within two years of our listing, and while we have considered it since then, we chose not to because of the resulting impact on our share price.

Moving strike convertible bonds have potentially the largest dilution and we have never considered them as an option. Moreover, we have commitment lines with several banks for ¥10bn which we have not drawn on as yet.

Why have you been able to work so regularly with Credit Suisse, rather than any other investment bank, in the public markets?

The primary motivation lies in the fact that Credit Suisse was able to understand our uniqueness, management ability and growth potential at an early stage and the commitment the organisation has demonstrated to our firm.

Our business model is radically different from existing retail businesses, and Credit Suisse valued this very highly. Also, we felt their approach was not based on pursuing short term profits, but on a more long term commitment to grow with the client. 

Nippon Sheet Glass — M&A financing a beacon for Japan's mid-caps
For the growing band of Japanese acquisition-hungry companies expanding across Japan and overseas, certainty of funding is paramount.

Nippon Sheet Glass Co's funding in March of its £2.2bn takeover of UK glass maker Pilkington with a ¥110bn moving strike convertible bond issue was a superb example of how Japan's mid-cap companies should go about their acquisition financings.

Nippon Sheet Glass Co's bold acquisition of UK glassmaker Pilkington for £2.2bn, announced in late February, was a milestone for corporate Japan. Not only was the deal bold, but so too was the financing package, which included Japan's largest ever moving strike convertible bond.

The ¥110bn bond, privately underwritten and bought 70% by Daiwa Securities SMBC and 30% by UBS, has far-reaching implications for M&A financing in Japan and for the private equity securities market. It should make other Japanese companies acquiring businesses think twice about going the public route to raise equity.

Nippon said it was using this funding technique because it offered a contingent funding mechanism, flexibility and low cost. It is unlikely whether any other financing technique would have served it as well.

Nippon Sheet Glass, Japan's second largest sheet glass maker, had its bid recommended by the Pilkington board. But the merger also needs clearance from competition authorities in other countries. It is due to close in June this year.

Among the moving strike convertable bond's many advantages, perhaps the most important was that the deal allowed Nippon to raise equity contingent on completion of the acquisition. SMBC and UBS have provided the money up front and committed to buy shares, but if for any reasons the acquisition does not go through, Nippon can cancel the deal and the underwriters will not convert the bonds.

For Japan's mid-market corporations eyeing a wide variety of acquisition opportunities around the globe, they would do well to understand the structure and function of the Nippon funding. 

01 Jun 2006