Chemicals company prepares for Hong Kong IPO

Most investors in the Hong Kong stock market are about to learn something new over the next few weeks as Chinese chemicals company Lumena Resources Corp gets ready to launch an initial public offering. While it is the world's second largest producer of thenardite, the company is likely to face a situation where few investors are familiar with the industry -- let alone know what thenardite is. That in mind, joint bookrunners BOC International, Credit Suisse and Macquarie, which kicked off pre-marketing activities on Monday this week, are planning to spend two full weeks on investor education with the formal roadshow scheduled to begin on June 1.

However, people familiar with the company say the deal is not really meant for a broad investor base, but rather will be targeted towards specialty funds, in particular those with a focus on the chemicals sector, or perhaps to small- and mid-cap funds. Investors who do take the time to look into this offering will find a high-margin company that has seen a 10-fold increase in net earnings over the past couple of years after a management buyout transformed it from a state-owned enterprise into a fast-expanding niche player in its sector. It has a domestic market share of 23%, which translates into 11% of the global market, and is expected to grow its net profit by 19% this year, without taking into account a potential capacity increase in the fourth quarter. Next year, earnings are expected to improve by close to 80%.

Such high earnings growth is typically an indication of a small-cap and, indeed, Lumena is expected to generate revenues of about Rmb1.3 billion ($190 million) in 2009 and have a market capitalisation of about $500 million at launch, which implies a deal size of about $125 million to $150 million. Sources say the number of shares to be sold hasn't been finalised yet as a portion of the offering will consist of secondary shares and the sellers of those are still weighing their options. The total deal is expected to account for approximately 30% of the enlarged share capital, however, with about 70% of that coming from new shares. The deal will have an overallotment option of only 10%, compared with the usual 15%, the sources say.

So, what then is thenardite? According to syndicate research, it is a solid form of sodium sulphate with a purity above 98% that can be produced either from natural minerals or as a chemical by-product. It is an important raw material for the production of powder detergents, dyes, textiles, glass, kraft pulp and pharmaceutical products -- the latter thanks to its mild laxative and anti-inflammatory qualities.

An edible, water-soluble, white, crystalline mineral powder, thenardite is produced using evaporates such a glauberite -- the largest reserves of which can be found in China, the US, Canada, Mexico, Spain and Turkey.

Lumena makes three types of products: powder thenardite, specialty thenardite and medical thenardite. The specialty product accounted for almost 70% of its revenues last year, while the medical product made up close to 17% and the powder product about 13.5%. Looking ahead, the company plans to focus on the first two as these have higher margins. The company sells more than 98% of its products in the domestic market, but count the Chinese operations of multinationals like Proctor & Gamble among its major customers.

Adding to its attraction, the Sichuan-based company is self-sufficient both in terms of mineral resources and power supply. The ore in its mines is also of high grade. Lumena currently has two operating mines -- Dahongshan and Guangji -- and last year acquired mining rights in the Muma Mining Area, also in Sichuan. The rights for all three of these mines are valid until 2038. The company expects to complete the construction of a 200,000 tonne per year production facility for medical thenardite at Muma by the end of this year and a 1 million tonne per year mining and production facility for specialty and powder thenardite in the same area in the third quarter 2010. This will add to its current annual production capacity of 1.6 million tonnes.

Adding to the challenge of getting investors to understand its business, there are no direct comparables either in China or abroad. Its larger rival Nafine, which has an annual production capacity of 1.65 million tonnes, is listed in China's A-share market, but syndicate analysts argue that the quality of its product is not as high as that of Lumena. One syndicate research report uses a 2009 earnings multiple of 9.7 times to calculate Lumena's fair value, which it says is in line with the average multiple of global peers in the chemicals sector. However, multiples seem to be varying a lot with Chile's Quimica Y Minera de Chile - the industry giant with a market cap of $8.7 billion - trading at a 2009 price-to-earnings multiple of 18 times, while India's Tata Chemicals and Indonesia's Akr Corporindo trading at 5.4 and 7.8 times respectively.

A separate syndicate report puts fair value in a range of 6 to 11 times this year's earnings, which are expected to end up just above Rmb500 million.

Another difficulty in terms of valuing the company is that thenardite is not a very actively traded commodity and the price outlook is therefore not particularly clear.

"A big question is what will happen to the price, but at least the company has the volume growth," says one banker familiar with the company.

Having begun operations as far back as 1952, then as state-owned Meishan Mirabilite, the company became a privately-owned enterprise in 2004 under its founder and chairman Suolang Duoji and CEO Zhang Daming. The founder currently owns 71% of the company, which will drop to 40% after the listing. Meanwhile, sources say a Credit Suisse-led consortium will hold about 5% of the enlarged share capital post listing. The consortium extended a $100 million loan to Lumena in June 2007 and while the company plans to use about 55% of the net proceeds to pay the loan off in full, the creditors also hold a set of warrants that will be exercised in connection with the IPO, resulting in the 5% stake.

Assuming the roadshow goes ahead as planned on June 1, the deal is expected to be priced towards the end of the week of June 8, with the listing scheduled for the following week.