However, it was quite obvious that none of the parties involved in the deal was that eager to rush at that time since the stockmarket was extremely jittery. Following the two interest rate cuts by the US Federal Reserve in late January, the volatility has decreased somewhat and the view is that the cuts have reduced the risk of a worst case scenario û namely a global recession. As a result, Honghua comes to market at what seems to be a slightly more favourable time for new listings and the company will no doubt be hoping to attract some of the cash that asset managers have been accumulating as they have reduced their equity exposure over the past two months.
The company, which is brought to market by Credit Suisse and Morgan Stanley, has had to reduce its earlier valuation expectations though, to reflect the fact that its sector peers have come off a bit since the pre-marketing. As a result, the deal will be slightly smaller than the $500 million to $600 million that was talked about earlier. If the 15% greenshoe is exercised in full, the total proceeds will be just over $550 million, however. The other deal terms havenÆt changed. The company is still selling 25% of its enlarged share capital in the form of 833.36 million new shares pre-shoe. The price range has been set at HK$3.16 to HK$4.50.
Despite having delayed its offering by a full month, Honghua can still become the first company of size to list in Hong Kong this year as the four companies that started to take orders in January all withdraw their offerings before pricing, either because of a lack of demand or because of concerns that the shares would trade poorly. Consequently Honghua will be closely watched by both bankers and other listing candidates that are keen to see whether investors are ready to commit money to new and untested companies. If this first deal after the Chinese New Year holidays goes well, it is likely to give the numerous other IPO hopefuls enough confidence to kick off their offerings. If it doesnÆt go well, these other companies may well decide to hold off for a bit longer.
According to observers, Honghua is a good test case for the market, however. For one, it is in the right sector as oil and gas companies are making lots of money because of the high spot prices and are investing heavily in new drill rigs û both to expand exploration into new areas and to replace existing equipment that is now dated. Aside from actual rigs, Honghua also makes rig parts and components for its own use and for sale and offshore drilling modules for offshore platforms. This additional business accounted for 17.5% of its revenues in the first eight months last year.
Between 2002 and 2007 the number of active land rigs globally grew at a compound annual growth rate of 10.4% to about 4,950 at the end of last year. 2007 was a very strong year with about 750 new rigs being built, but according to HonghuaÆs listing prospectus the demand will remain strong and average about 440 rigs per year in 2008-2012. About 70% to 80% of that demand will come from China and Russia, with much of the remainder coming from other emerging markets in Africa, the Middle East and Latin America.
Given HonghuaÆs proximity to both the Chinese and Russian markets, this puts it in a good position to capture a greater part of the market. In 2006, about 83.5% of the companyÆs revenues came from exports and in the eight months to August last year that figure was 54.6%
Based in Sichuan province, the company is also the second largest land rig manufacturer in the world with a market share that is currently just under 20% but increasing. Because of the long construction time, there is good visibility about earnings for the next one to two years. And like many other Chinese companies in various sectors, Honghua has a much more aggressive growth profile than its key global competitors, making it an attractive choice for investors. Investors who met with the company on the first day also said they were impressed by the knowledge of the Honghua management.
Equally important though û especially in light of the market environment û is the valuation and it remains to be seen whether investors are willing to support the company at the indicated levels. According to sources, the price range values the company at 12.1 to 17.1 times its projected 2008 earnings (pre-shoe).
At first glance these levels looks reasonable, because despite the market downturn over the past three months, it is still not that easy to find good quality industrial companies in the Hong Kong market at 12 times earnings. The price also represents a significant discount to London-listed Russian competitor Integra Group at about 21 times. The bottom end of the price range is at a discount to the worldÆs largest oil rig manufacturer National Oilwell Varco (NOV), which is listed in the US and trades at 13.4 times, while the top end is at a premium.
That premium is believed to be reasonable, however, as NOV is expected to generate net earnings growth in the teens this year, compared with a growth rate of more than 50% for Honghua. The company is estimating that its net profit grew by about 30% in 2007 to at least Rmb538.3 million ($75 million).
On an enterprise value to Ebitda basis, HonghuaÆs price range translates into a multiple of 6.3 to 8.8 times, according to one source. This compares with 7.6 times for NOV and 7 times for Integra.
The bookrunners decided not to include any cornerstone investors, but according to sources they did encourage large institutional investors to submit their orders early in return for being treated as anchor investors. Anchors typically donÆt get a guaranteed pre-agreed allocation and donÆt have to accept a lock-up, but they are treated favourably when it comes to allocations and can be just as helpful in terms of building momentum in the order book.
The message to investors when the roadshow started yesterday was that the bookrunners already had firm anchor indications in excess of half the deal. This could prove important for giving other investors the confidence to submit orders as well.
"It is also quite well accepted that IPOs that are completed in difficult markets can lead to good return for investors," says one source.
Indeed, such deals typically require larger valuation discounts which can quickly be ironed out when the market starts to recover and the focus shifts back to fundamentals again. This could help attract investors who understand the industry and are willing to accept a bit of volatility in the short-term.
Honghua already has a group of well-regarded international financial investors as shareholders, who bought in through a convertible note in November 2006. These include a number of funds controlled by Carlyle, which will hold 5% after the IPO, as well as Vincera Group, DPF and IPO Cathay which will own a combined 2.7%.
Honghua also has a strategic relationship with its largest customer Nabors Industries which became an investor in the company in 2005 and will hold 13.5% at the time of the listing. Nabors, which is listed in the US and conducts drilling operations for both oil and gas, accounted for 64% of the HonghuaÆs revenues in 2006 and 32.3% in the eight months to August last year.
Offshore oil giant CNOOC also holds a 5.2% stake through a wholly-owned subsidiary under the name of COOS.
Honghua delivered 89 rigs last year and is planning to increase its land rig manufacturing capacity to 150 rigs this year. It will spend about 12% of the net IPO proceeds to achieve this. However, it isnÆt expected to manufacture that many straight away. One syndicate analyst estimates that it will deliver 106 rigs in 2008.
As an added growth kicker for the future, the company is also planning to move into the manufacturing of off-shore rigs, also known as jack-up rigs, which are more complex and expensive and therefore carries higher margins. Honghua will set aside about 60% of the net proceeds, or about $300 million, to construct a manufacturing base for these types of rigs on the eastern coast of China. It has yet to acquire the necessary land, however, and the construction isnÆt expected to be completed until 2009 or 2010.
The IPO is split the usual way with 10% of the shares earmarked for retail investors and rest for institutions. But standard clawback triggers apply and could boost the retail tranche to as much as 50% of the deal in case of strong demand.
The Hong Kong public offering will open on Monday and the final price will be determined on February 29. The trading debut is scheduled for March 7.
Honghua is likely to be followed most immediately by China Railway Construction, which has been pre-marketing since last week and is expected to launch the roadshow for the H-share portion of its dual-listing in Shanghai and Hong Kong early next week. The construction company is aiming to raise about $4 billion from the combined offering.
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