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Debt Market / Special Report December 10, 2010

LUKOIL sells a convertible bond

Yuri Nefyodov Interesting hybrid


Fact sheet: Convertible bond
Investment conclusion
Convertible bond is a hybrid instrument, consisting of a Yesterday, LUKOIL announced that it placed through its Dutch SPV LUKOIL International Finance
plain vanilla bond and equity call option. Therefore the B.V., a convertible bond totaling $1.5bn at a rate of 2.625% for 4.5 years. We believe that LUKOIL
bond price behaves like a call option when the stock convertible bonds are an interesting investment instrument. We estimate that asset price indicates
price approaches the exercise (strike) price, and like a
plain vanilla bond if the option is out of money.
strong resilience to the yield growth if LUKOIL’s ADR stay in the $50-60 range on the 3-month time
interval. When ADRs reach the target ($73.25), set by our stock market analysts, the bond price will
The price of the convertible bond has a so-called floor dip below 100% only in case of dramatic yield growth. We note that at the moment the instrument
price (the lowest economically justified price) as the
price for the instrument can not be below the trades above par (see under the tag of ALLQ in Bloomberg for EI506594 Corp).
conversion value (conversion rate multiplied by current
stock price).
Instrument metrics
The price of the instrument depends on interest rates According to the issuer, the reference price is set at $56.699 for ADR, the premium amounts to 30%.
as well as stock price volatility. It means that the strike implied in the bond is $73.7087 (thus the conversion rate equals to 1 357
ADRs per bond). Therefore if LUKOIL’s ADRs trades above this level, bond conversion into stocks
will be feasible. The conversion period starts in 40 days after the placement, i. e. on January 25,
Potential call option profit
2011.
We note that after December 31, 2013, LUKOIL will be eligible to buy out bonds at 100% of par, if the
conversion value exceeds 140% of par. The highest implied ADR price amounts to $103.
Bond parameters
# Calculation Price # Calculation Price
1 CCY USD 15 Call feature
2 Par value 100 000 16 Start 31.12.2013
3 Bonds Issued 15 000 17 Buy back price 100%
4 Coupon 2.625% 18 Call strike 140%
5 Day count 30/360 19 (2)*(18) Call strike CCY 140 000
Source: Bank of Moscow Research Department 6 Reference price 56.699 20 (19)/(9) Implied Share max price 103
7 Premium 30% 21 (21)/10)-1 Share performance to trigger 81%
8 (6)*(1+(7)) Strike 73.7087 22 Ratios
9 (2)/(8) Convertion ratio (ADR/bond) 1 357 23 (9)*(10) Conversion value 77 264
10 Current stock price 56.95 24 (13)/(9) Market conversion price 73.7087
11 Exp divs 1.75 25 (24)-(10) Convesrsion premium per sh 16.76
12 Straigh Bond value 89 958 26 (25)/(10) Conversion premium % 29%
13 Maket price 100 000 27 Premium above straight value 11%
14 (13)-(12) Conversion option value 10 042

LUKOIL yield curve and convertible bond


7.0

6.5 Lukoil' 22
Lukoil' 19
6.0 Lukoil' 20

5.5 LUK-NOT-CONV Lukoil' 17


5.0 Lukoil' 14
4.5

4.0 Conversion option


value 235 bpts
3.5

3.0

2.5 LUK-CONV-15

2.0
3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0

Source: Bank of Moscow Research Department

© Bank of M oscow 1/ 3
Fixed Income Special Report December 10, 2010

Placement results
If we disregard the option part, LUKOIL placed the issue with a 235-bpts discount to the eurobond
curve. In reality, the spread of 235 bpts in yield (11 ppts in price) is the conversion option value. We
believe that implied option volatility amounted to about 25%. This estimate is in line with long-term
implied market volatility for call options with strike price of 130%. Yesterday we saw offer prices for
June 2011 with 30% volatility.
We analyzed bond price sensitivity on the three and 12-month period (see the tables below) and
drew the following conclusions:
• If LUKOIL’s ADR trade in the range of $50-60 and volatility increases to 40% with the
change in the yield curve by 50 bpts (up or down), investments in the instrument will be
efficient.
• If LUKOIL stocks reach in 12 months the $73.25 target, set by our analysts, the bond price
will dip below par only in case of dramatic yield growth by 300 bpts. As these events are
mutually exclusive and taking in to account the BUY recommendation on LUKOIL, we
recommend LUKOIL’s convertible bonds as well as we don’t expect material yield growth in
the eurobond market in the next several months.

Sensitivity analysis of LUKOIL’s convertible bonds (including ACI)

16/03/11 LKOD LI 60.000


Yield shift, bp
-100 -75 -50 -25 0 25 50 75 100 200 300
20% 100.30% 99.39% 98.50% 97.61% 96.74% 95.88% 95.02% 94.18% 93.35% 90.12% 87.04%
25% 103.20% 102.29% 101.40% 100.51% 99.64% 98.78% 97.92% 97.08% 96.25% 93.02% 89.94%
30% 106.21% 105.30% 104.40% 103.52% 102.64% 101.78% 100.93% 100.08% 99.25% 96.02% 92.94%
Vol 40% 112.29% 111.38% 110.48% 109.60% 108.72% 107.86% 107.01% 106.16% 105.33% 102.10% 99.02%
50% 118.27% 117.37% 116.47% 115.59% 114.71% 113.85% 113.00% 112.15% 111.32% 108.09% 105.01%
60% 124.04% 123.13% 122.24% 121.35% 120.48% 119.62% 118.76% 117.92% 117.09% 113.86% 110.78%
70% 129.50% 128.59% 127.70% 126.81% 125.94% 125.08% 124.22% 123.38% 122.55% 119.32% 116.24%

16/03/11 LKOD LI 50.000


Yield shift, bp
-100 -75 -50 -25 0 25 50 75 100 200 300
20% 96.94% 96.03% 95.14% 94.25% 93.38% 92.52% 91.66% 90.82% 89.99% 86.76% 83.68%
25% 98.90% 97.99% 97.10% 96.21% 95.34% 94.48% 93.62% 92.78% 91.95% 88.72% 85.64%
30% 101.15% 100.24% 99.34% 98.46% 97.58% 96.72% 95.87% 95.02% 94.19% 90.96% 87.88%
Vol 40% 106.05% 105.14% 104.25% 103.36% 102.49% 101.62% 100.77% 99.93% 99.10% 95.87% 92.79%
50% 111.11% 110.20% 109.30% 108.42% 107.55% 106.68% 105.83% 104.99% 104.15% 100.93% 97.85%
60% 116.10% 115.20% 114.30% 113.42% 112.54% 111.68% 110.83% 109.98% 109.15% 105.92% 102.84%
70% 120.91% 120.01% 119.11% 118.23% 117.35% 116.49% 115.64% 114.79% 113.96% 110.73% 107.65%

16/03/11 LKOD LI 40.000


Yield shift, bp
-100 -75 -50 -25 0 25 50 75 100 200 300
20% 95.27% 94.36% 93.47% 92.58% 91.71% 90.84% 89.99% 89.15% 88.32% 85.09% 82.01%
25% 96.25% 95.35% 94.45% 93.57% 92.69% 91.83% 90.97% 90.13% 89.30% 86.07% 82.99%
30% 97.62% 96.71% 95.81% 94.93% 94.05% 93.19% 92.34% 91.50% 90.66% 87.43% 84.36%
Vol 40% 101.05% 100.15% 99.25% 98.36% 97.49% 96.63% 95.77% 94.93% 94.10% 90.87% 87.79%
50% 104.96% 104.06% 103.16% 102.28% 101.40% 100.54% 99.69% 98.84% 98.01% 94.78% 91.70%
60% 109.01% 108.10% 107.21% 106.32% 105.45% 104.58% 103.73% 102.89% 102.06% 98.83% 95.75%
70% 113.01% 112.10% 111.21% 110.32% 109.45% 108.59% 107.73% 106.89% 106.06% 102.83% 99.75%

16/12/11 LKOD LI 73.250


Yield shift, bp
-100 -75 -50 -25 0 25 50 75 100 200 300
20% 108.39% 107.63% 106.88% 106.13% 105.39% 104.66% 103.94% 103.22% 102.52% 99.76% 97.11%
25% 111.79% 111.02% 110.27% 109.52% 108.79% 108.05% 107.33% 106.62% 105.91% 103.15% 100.50%
30% 115.15% 114.39% 113.63% 112.89% 112.15% 111.42% 110.70% 109.98% 109.27% 106.51% 103.87%
Vol 40% 121.76% 121.00% 120.24% 119.50% 118.76% 118.03% 117.31% 116.59% 115.88% 113.12% 110.48%
50% 128.16% 127.40% 126.64% 125.90% 125.16% 124.43% 123.71% 122.99% 122.28% 119.52% 116.88%
60% 134.30% 133.54% 132.79% 132.04% 131.30% 130.57% 129.85% 129.13% 128.43% 125.67% 123.02%
70% 140.15% 139.39% 138.63% 137.89% 137.15% 136.42% 135.69% 134.98% 134.27% 131.51% 128.86%

Source: Bank of Moscow Research Department

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Fixed Income Special Report December 10, 2010

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