• We have never seen a succession of such large U.S. dollar-denominated convertible bonds from Chinese companies. In fact, the $5 billion convertible bond issuance by Alibaba in May was the largest dollar-denominated convertible issuance globally since 2008.¹
• Most of the firms issuing these convertible bonds have ample cash on their balance sheets. The impetus for their sudden spate of large-scale issuance is therefore rather unclear.
• These firms might need U.S. dollars to finance their international expansion; or these companies might be acting opportunistically on a perception that market conditions are favorable for such issuance; or the surge might reflect a new tolerance by Chinese capital market authorities to permit such issuance; or – perhaps most worryingly – these companies have been blocked from exchanging their ample cash balances (denominated in renminbi, and held onshore in China) into dollars.
• If the latter, the surge signals that China has once again placed substantial restrictions on convertibility for the country’s capital account.

Since May 2024, several notable Chinese companies have issued dollar-denominated convertible bonds in unusually large size, as shown in Figure 1. It is unclear why these companies have selected this form of financing at this juncture, but it is clear that such large-scale convertible issuance from Chinese issuers is unprecedented. In fact, the $5 billion issuance by Alibaba in May was the largest dollar-denominated convertible bond placed globally since 2008.

Why are Chinese corporates tapping the dollar convertible market in such size now? Potential reasons include: a basic need for dollars to finance global operations; simple capital markets opportunism; regulatory changes making such bonds easier to issue amid domestic capital market constraints; or, perhaps these bonds indicate that some Chinese companies are constrained in their ability to exchange their large, renminbi-denominated cash balances for offshore dollars to support projects outside China. Whatever the reasons, this wave of large U.S. dollar convertible bonds from Chinese companies is unusual, and may well have consequences for investors in China.

A Need for U.S. Dollars

The most straightforward explanation for this wave of dollar-denominated convertible bonds is that these companies need U.S. dollars. Most have stated as much directly in their relevant bond prospectuses. Yet most of these companies do not appear to need more cash on their balance sheet – all of these issuers have renminbi equivalent to billions of dollars (see Figure 1). The publicly-stated use of proceeds for the issuances revolves around stock buybacks (via the repurchase of dollar-denominated American Depositary Receipts (ADRs)); global expansion; and dollar-debt refinancing. Alibaba, JD.com and Trip.com all stated that a portion of the proceeds would be used for share repurchases, specifically their dollar-denominated ADRs. Some of these companies also disclosed that a portion of the proceeds would be used for expansion overseas, improving their supply chain network, or refinancing overseas indebtedness. At face value, these companies need U.S. dollars to accomplish their stated goals.

Capital Markets Opportunism

But why would a spate of large-scale issuance occur now, especially when most of the issuers have not tapped dollar-denominated convertible markets previously? Perhaps the issuers perceive that market conditions and pricing terms for dollar convertible bonds are more favorable than other funding sources right now. The increase in global interest rates over the past few years may have led these companies to conclude that such instruments make the most sense right now, at least as it relates to ongoing interest payments.² The issuers have all achieved coupons on their convertibles at or below one percent. One could argue that such low coupon rates constitute a relatively “cheap” source of funding which could be used for stock repurchases, expansion overseas, or upgrading supply chain networks. So perhaps this wave of convertible bonds is simply a reflection of Chinese companies taking advantage of a trend in capital market financing driven by interest rate changes.

Frankly, I see this explanation as unlikely. Convertible bonds, by their very nature, are ultimately a very “expensive” form of financing within a corporate capital structure given their hybrid nature. As such, they are typically issued by smaller companies that have low credit ratings or which lack repayment track records, and which often have a relatively urgent need for cash.³ Most of the companies listed in Figure 1 do not fit that description: some are rated, most are well-established businesses capable of repayment, and all have significant cash balances, ostensibly ruling out desperation.

Regulatory Changes

Another possible explanation for this wave of convertibles is that Chinese regulators have made it easier to issue dollar-denominated securities – or perhaps even encouraged it via changes in regulatory approvals. All Chinese companies need approval from the China Securities Regulatory Commission (CSRC) for overseas offerings. The CSRC issued new regulations in March of 2023 related to overseas listings and offerings by Chinese companies.⁴ Of note, these new regulations lay out a timeline for approvals, requiring the CSRC to provide a decision 20 days after companies file for approval . More recently, the CSRC announced several measures aimed at managing market values, including the promotion of mergers and acquisitions transactions and enhancing the efficiency of restructuring transactions.⁵⁶ These announcements were part of a series of stimulus measures aimed at stabilizing China’s economy.⁷

Recently, we have observed some strains in China’s domestic capital markets. There have been relatively few initial public offerings (IPOs) in the China A-Share market in 2024 due to increased regulatory scrutiny focused on the quality of the companies tapping the domestic markets.⁸ News reports suggest that the regulators are stymying IPO approvals as they want domestic investors to purchase the existing stock of equities instead of those of newly listed (and sometimes better) companies . Chinese authorities have said they want to improve the business environment for the private sector, and maybe part of that is allowing certain companies to access dollar financing for specific purposes . With the Chinese economy and the domestic capital markets facing significant challenges, these large dollar bond issuances may have been spurred by a relaxation in regulations for overseas offerings for selected companies.

Capital Account Constraints and Renminbi Convertibility

As mentioned earlier, convertible bonds are generally a funding option of lesser resort. These can be costly instruments, theoretically more expensive than ordinary bonds and often dilutive to equity holders. Convertibles are rarely a healthy company’s first financing option. Rather, healthy companies typically avoid “hybrid” instruments, and opt for an equity issuance via rights offerings, or the issuance of a low coupon “straight” (non-convertible) bond. Because the companies mentioned in this commentary don’t appear to need more cash, it is possible that their issuance indicates something altogether different: perhaps they can’t get their cash out of China to support their overseas operations or for overseas debt refinancing.

If so, this is a worrisome signal for investors: it implies that not only has China re-imposed greater control over convertibility of the renminbi through the country’s capital account, but also that investors can’t necessarily be assured that the cash that sits on a given balance sheet is fully at the disposal of the company in question.

Two other recent, curious financial transactions by prominent Chinese companies – but not convertible bonds – raise similar questions. A global appliance maker called Midea recently offered a large tranche of stock via an IPO in Hong Kong. What made this transaction unusual was that Midea had publicly-listed shares in the domestic China A-share market, and it ostensibly had ample cash on hand; yet it was willing to issue new shares in Hong Kong at a substantially discounted (and therefore dilutive and costly) price relative to its existing A-shares.⁹ Companies usually don’t issue shares at a meaningful discount to their primary listing without an imperative. In this case, one can surmise that the listing in Hong Kong will provide the company with a currency that can easily be used for overseas expansion or debt refinancing.

The second odd transaction occurred when a Chinese electric battery maker called Contemporary Amperex Technology Co. (CATL) pursued a novel route to fund future acquisitions outside of China.¹⁰ Instead of pursuing such acquisitions by itself, CATL chose to create a co-mingled, offshore fund, financed by sovereign wealth funds and “private family offices.” While there is nothing necessarily wrong with joint investment, CATL’s choice is still odd: partnering with other entities via co-mingled investment means a loss of direct control, and higher ongoing costs for coordination, governance and operations. The choice is all the odder given that CATL dominates its industry, and is therefore not likely to benefit from any special capabilities or technical assistance from its partners in the fund; and it has ample cash on hand already, the equivalent of over $40 billion. CATL’s choice is seemingly impractical; perhaps it implies something about CATL’s ability to utilize its own balance sheet directly for acquisitions. Is it possible that restrictions on China’s capital account have curtailed CATL’s ability to spend its own funds outside of China?

This recent set of transactions by Chinese companies – dollar convertibles, heavily discounted offshore IPOs, and costly joint funding arrangements – are all alternative means to raise capital outside of China, in U.S. dollars (or currencies that are readily exchangeable for dollars). Collectively, this series of transactions might reveal heightened restrictions on China’s capital account, restrictions that are crimping Chinese companies’ ability to use their own balance sheets for overseas activities.

Conclusion

Whatever the reasons for this year’s dollar convertible bond issuance boom from Chinese companies (and the reasons very well could be different for each of these issuers), this trend is something to watch. Most of these companies have ample cash on their balance sheet, so it is curious why they would want more cash now – and cash which may well result in equity dilution later. Perhaps the issuers perceive the financing to be “cheap,” at least in terms of current coupon rates – but given the size of the issuances relative to existing cash balances, I think that there are likely other motivations and explanations. Investors should keep an eye on this market – as it may serve as a key signal for the level of convertibility of the renminbi, and it might convey information about the unwelcome, government-imposed constraints that continue to hinder China’s private sector.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

As of September 30, 2024, securities mentioned in this commentary comprised the following weights in the Seafarer Overseas Growth and Income Fund: Alibaba Group Holding, Ltd. (2.4%). As of September 30, 2024, the Seafarer Funds did not own shares in the other securities mentioned in this commentary. View the Top 10 Holdings for the Seafarer Overseas Growth and Income Fund and the Seafarer Overseas Value Fund. Holdings are subject to change.

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