Zhongwang prices IPO towards low end

China Zhongwang Holdings has priced its initial public offering at HK$7 per share, towards the low end of the indicated range of HK$6.80 to HK$8.80, offering further evidence that this is still a buyer's market. Even at the low end though, the company was able to raise HK$9.8 billion ($1.26 billion), which makes this the largest IPO globally this year, ahead of Mead Johnson Nutrition's $828 million US offering in February.

Zhongwang, a Chinese manufacturer of aluminium extrusion products, received solid support from institutional investors who welcomed the large scale of the offering, which suggests that it will be a liquid stock -- something that investors value amid the volatile equity market environment. Other attractions were a valuation that was referred to by several investors as "reasonable", and the fact that the company's products are targeted primarily at the transport sector, and the railway industry in particular. This makes it an indirect beneficiary of the government's aggressive build-out and spending plans for the railway sector and the country's Rmb4 trillion ($585 billion) stimulus package, which is to a large extent focused on infrastructure spending.

Retail investors were less convinced, however. Perhaps because the previous two IPOs of size in Hong Kong this year have performed poorly and by the time the Zhongwang retail offering closed on Wednesday last week, they were both still trading below their respective IPO prices, perhaps the deal didn't have the stated support by any Hong Kong tycoons as has typically been the case in the past when large Chinese corporations list in Hong Kong.

Either way, the retail subscriptions were enough to cover only 70% of the shares earmarked for them, leaving institutional investors to pick up the leftovers. The retail tranche was meant to account for at least 10% of the total deal, or about $126 million at the final price. However, even at 70% of that, Hong Kong retail investors will hold about $88 million of the deal when it starts trading on Friday, which is a decent amount.

Market watchers say the lack of interest among retail investors may turn out to be positive for the company as many of them tend to take profit as soon as they can. A smaller retail tranche may therefore reduce the selling pressure in the first couple of days.

The institutional subscription rate wasn't disclosed, but with about 24 hours left to go, the bookrunners -- Citic Securities, J.P. Morgan and UBS -- told investors that the institutional tranche was already twice covered. More than 100 investors submitted orders and according to one source, the interest from the US and Europe was greater than on any other Asian deal for some time. Again this was likely because of the size, which gave large investors a good chance of getting a meaningful chunk of shares. By comparison, the other two IPOs in Hong Kong this year -- Real Gold Mining and liquor distributor Silver Base -- raised just over $130 million apiece.

In addition to the large absolute size, sources say Zhongwang did not have the explicit backing of cornerstones or anchor investors, which again leaves more shares for institutional investors. "Nobody likes to do a lot of work and then receive just a small number of shares," says one banker. "There were no pre-allocated parts of the deal so investors had the full deal to play for."

Of course, not all investors would view this as a positive. In fact, the inclusion of anchor investors, who pre-commit to buying a specific number of shares or deal amount before the official bookbuilding starts, are typically viewed as helpful in terms of getting momentum going in the order book. Uncertainty about what direction the markets may take while the deal is on the road, and between the pricing and the actual trading, is making it harder to convince anchors to step in, bankers say. And, by the same token, it is almost impossible these days to attract cornerstones, which also need to commit not to sell the shares for a pre-determined period -- typically during the first six or 12 months after listing.

The Hang Seng Index gained 4.1% during the eight-day roadshow that ended last Wednesday and there is a risk that the market may have to absorb another wave of selling when it reopens today after Hong Kong registered its first case of swine flu over the long weekend. The case led to the quarantine of an entire hotel in the Wan Chai district of the city.

The final price values Zhongwang at 10.7 times its 2009 earnings based on consensus projections by the three bookrunners. This puts it at only a small premium versus Singapore-listed Jilin Midas, which is viewed as the closest comparable in terms of the actual business. However, Zhongwang is 20 times larger than Midas in terms of output, has 10 times the revenue and 12 times the net profit. As of last year, Midas did however have a higher net profit margin of 22.6%, compared with 17% for Zhongwang, but as Zhongwang continues to shift its product mix towards the industrial sector, syndicate analysts expect its margin to exceed 30%.

Consequently, the syndicate analysts believe Zhongwang deserves to trade at a premium versus Midas. However, they also agree that it should come at a discount to downstream customers such as China South Locomotive and Rolling Stock, China Railway Group and China Railway Construction, which are driven by the same macro trends. As of last Friday, Midas was trading at a price-to-earnings ratio of 10.1 times, while China South Locomotive was at 18.6 times, China Railway Group at 18.1 times and China Railway Construction at 19.5 times. 

Zhongwang, which is based in the Liaoning province in northeastern China, posted a 124% rise in net profit to Rmb1.9 billion in 2008 on a 24% increase in revenues, thanks to an improvement in profit margins resulting from a continued shift in its product mix from construction products to moulded industrial products, such as railway carriages, light trucks, automobiles, aircraft and power transmitters, which are more customised, have higher entry barriers and are generating much faster revenue growth. According to syndicate research, the net profit is expected to be at least Rmb3 billion in 2009, which implies 58% growth versus last year.

Zhongwang sold 25.9% of the company in the form of 1.4 billion new shares, plus a 15% overallotment option. Immediately following the IPO, before a potential exercise of the overallotment option, the company's founding chairman, Liu Zhongtian, will own the remaining 74.1%. However, he may have to give up some of that to private equity firm Olympus Capital who bought $100 million worth of Zhongwang exchangeable notes in August last year, which can be exchanged into shares held by Liu starting from six months after the listing.