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What Should Investors Make Of OSIM International Ltd.’s New Convertible Bond Issue?

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Just yesterday, massage chair and luxury tea purveyor OSIM International Ltd. (SGX: O23) announced that it will be issuing S$170 million in convertible bonds.

What does this mean for the company and its investors?

Bonds… James Bonds?

Let’s start with the nitty-gritty details of the bond. The bond to be issued by OSIM is a convertible S$170 million zero-coupon bond with an “upsize option” of S$30 million. The 5-year bond will have an effective annual interest of 2% and includes both a call and a put option.

Slow down a minute!

What do all these mean? Fear not for I’m going to break it down.

OSIM will be raising a principal amount of S$170 million through the bond. On top of that, there is an option for the company to increase the size of the bond to S$200 million if there is enough investor demand. The bond will be issued on 18 September 2014 and will be due exactly five years later on 18 September 2019.

Being a zero coupon bond, it would mean that OSIM will not be making any interest payments to bondholders throughout the duration of the bond. Instead, it will only pay the full accumulated interests when the bond matures. The accumulated interest comes about because OSIM would be redeeming the convertible bond at maturity (that would be on 18 September 2019) at 110.46% of the principal amount (the principal amount would be S$170 million or S$200 million, depending on whether the upsize option is exercised).

The bond is also convertible in nature, meaning that bondholders would have the option to convert their bonds into new issued shares of OSIM. The bond can be converted to shares at a price of S$3.525 per share. That’s roughly 25% higher than OSIM’s closing share price of S$2.82 on 26 August 2014. If fully converted, the bond will lead to OSIM having to issue 48.227 million new shares; that’s roughly 6.19% of the company’s share count as of 26 August 2014.

We’ve finally come to the put and call option, which is actually quite typical for convertible bonds. The presence of the options simply allows the company or bondholders to ask for early redemption of the bonds if certain criteria are met.

So… what?

With OSIM required to redeem the convertible bonds at 110.46% of the principal amount on 18 September 2019 assuming they’re not converted into shares,  the company’s actually paying an effective annual interest rate of 2% to borrow that capital.

That’s a cheap source of funds for what’s effectively a five year loan. At the very least, it’s much cheaper than the current convertible bonds which OSIM had issued back in 2011 – those convertible bonds had carried an effective annual interest rate of 4.39%.

Besides being cheap debt, the convertible bonds might also reveal an interesting facet of management’s thinking toward OSIM’s share price. Given that management’s willing to make the bond a convertible one just to achieve a lower effective interest rate (convertible bonds generally come with lower interest rates as compared to normal bonds, all else equal), it might be an indication that OSIM’s management thinks that the company’s shares are not undervalued – thus, it will benefit shareholders if the company issues new shares at the price of S$3.525 in the future.

Hopefully, OSIM can put the cheap capital to good use. On that front, these are the company’s comments on what it intends to do with all that money:

“OSIM intends to use the net proceeds of the issue to roll out and enhance its well-being and lifestyle business in Asia and beyond, finance potential strategic acquisitions which OSIM may pursue as part of its strategic objectives and general working capital.”

Foolish Summary

In all, despite presenting a small amount of dilutive risk to current shareholders of the company, OSIM’s latest convertible bond issue is a source of very cheap funding. That’s especially so if  the company is able to put the money to good use and earn a respectable rate of return that’s much higher than 2% a year.

But, be wary if the company decides to use the money to pay out special dividends or build opulent new headquarters though!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.