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Singapore-based firm starts fund to buy 'death spiral' convertibles

Such bonds get bad rap for dilutive nature; but Advance Capital says fund takes on huge risks partnering issuers in dire straits

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A Financier that specialises in a controversial form of convertible financing has launched its first fund to public clients, hoping to benefit from tight capital raising conditions for smaller companies.


A FINANCIER that specialises in a controversial form of convertible financing has launched its first fund to public clients, hoping to benefit from tight capital raising conditions for smaller companies.

Advance Capital Partners is marketing its Advance Opportunities Fund I to high net worth individuals and institutional investors.

The firm and its fund specialises in convertible bonds that have been called "death spiral convertibles" because of their dilutive impact on the underlying shares. Under Advance Capital's programme, a listed company that is in need of funds will issue to Advance Capital convertible notes that are convertible into new shares of the company at a fixed discount to the current market price. Because the notes set the conversion discount, and not the price, some notes have the potential to create a runaway negative impact on the underlying stock as each round of conversion gets even more dilutive.

Advance Capital has previously made such deals with Attilan Group (the former Asiasons Capital), Elektromotive Group, Yuuzoo Corp, Cacola Furniture International and OLS Enterprise. Other firms that are active in such programmes include Value Capital Asset Management, which has made deals with Annica Holdings, ISR Capital, Magnus Energy Group and LionGold Corp.

Given the high cost of such capital, the convertibles are usually used by companies that are in relatively dire need for cash, although the firm is hoping to also strike deals with healthier companies.

"We are entering a phase in the economic cycle where the strategy that's adopted by this fund works the best," Advance Capital adviser Geoffrey Ng told potential investors at a marketing session in Singapore. "The economies of Asia are slowing and slowing quite drastically, and more importantly, it's the access to capital. Access to capital by a lot of companies is now starting to be a challenge, especially in the space that we play in, which is the small and mid-cap companies."

The fund has an initial seed capital of US$10 million, and is targeting US$50 million for its first close, and US$80 million for a future second close. The fund is targeting a return of 25 per cent per year after fees, and Advance Capital founder Tan Choon Wee said that he has a US$200 million pipeline of potential deals from around Asia that could become assets for the fund.

Advance Capital does not intend to hold the convertible bonds to maturity - Mr Ng told The Business Times that the bonds typically carry only a nominal coupon that is insufficient to cover the credit risk of the issuer. Instead, Advance Capital prefers to convert the notes into shares, and to sell the shares within a few days of conversion for a profit.

While Advance Capital is exposed to the risk of default from the bond issuers, it is more concerned about the liquidity of the underlying stock.

Mr Tan said: "The risk is when we do a drawdown and have certain notes exposed . . . and the company's stock gets suspended overnight. That's the biggest risk we face."

Advance Capital is also fighting criticism that the kind of financing provided by the firm can be extremely lopsided in its favour, and highly costly for the issuers' existing shareholders.

For example, the notes that Advance Capital holds are always convertible into equity at a discount to the prevailing market price, giving the firm an instant profit upon conversion. If the borrower defaults, Advance Capital does not have to convert its bonds, and can therefore rank ahead of equity holders as a creditor. And if Advance Capital ever needs to influence certain shareholder votes, or even take over a company, it may have enough shares that it can acquire through conversion to get its way.

"We've only been caught once, whereby the company got delisted," Mr Tan told potential investors at a marketing event in Singapore. "And even then, also, we were the single largest shareholder, and today we control that company."

Mr Tan stressed that his programmes include safeguards for issuers. Advance Capital also needs to be seen as a partner for its borrowers if it is to continue finding deals for its funds.

"Key for me is building my reputation and track record," he said. "We don't want to be seen as predatory, so we try to be as fair as we can be but at the same time containing the risk for my investors."

But Advance Capital will ultimately still have to protect its investment.

"We are the ones coming up with the money," Mr Tan said. "It's capital at risk for us. Don't say we're cheating anyone. We're putting our money where our mouth is."