Massive demand for Sinopharm bodes well for IPO pipeline

Sinopharm, the largest distributor of pharmaceutical products in China and the first company to price a Hong Kong initial public offering in the current flood of IPOs, received massive demand from both institutions and retail investors, according to sources.

The response, which was described as "crazy" by some bankers working on the deal, allowed Sinopharm to fix the price at the top of the range for a deal size of HK$8.73 billion ($1.13 billion), and should bode well for the multitude of other listing hopefuls currently in the market or awaiting their turn with the listing committee.

However, some observers pointed out that Sinopharm may have been a special case in that it is both the dominant player in an industry that is expected to see significant growth in the years ahead, and a state-owned enterprise, with the implicit support from Beijing that such a position typically entails. It is also the only large player listed outside of China to offer exposure to the Chinese healthcare sector. Consequently, the strong order flow for Sinopharm may not necessarily translate into similar demand for other IPOs, but it is at least clear that investors are sitting on a lot of cash that they are prepared to invest in "the right" market newcomers.

Sources said the Sinopharm deal attracted about $50 billion worth of institutional orders, which includes demand from high-net-worth individuals and corporates, and another $60 billion from Hong Kong retail investors. The 10% retail tranche was said to have been about 560 times covered, which implies that it tied up about HK$489 billion ($63 billion) of cash during the subscription period, making it the second most popular retail IPO in Hong Kong after Railway Construction Corp's IPO last year, which tied up HK$531 billion worth of retail cash.

This means that it was more popular among retail investors than BBMG Corp's $768 million IPO in July, which attracted HK$458 billion worth of retail dollars. Notably, BBMB was rather alone in the market at the time, while Sinopharm is competing for investor attention with numerous other deals, including Metallurgical Corporation of China's (MCC) dual A- and H-share listing. MCC is due to price the H-share portion of up to $2.5 billion today after fixing the A-share price at the top of the range last week.

Aside from sucking liquidity out of the Hong Kong interbank market, a direct consequence of the retail subscription frenzy is that there will be a full clawback that will increase the retail tranche to 35%. After also deducting $195 million worth of shares that were bought by nine cornerstone investors, this leaves $540 million of stock to be allocated among more than 700 accounts that submitted orders for the institutional tranche. A job that will no doubt keep the three joint bookrunners -- China International Capital Corp, Morgan Stanley and UBS -- busy for quite awhile.

By comparison, the pricing call would have been a quick and easy affair. With so much demand there was really no option but to fix the price at HK$16, the top of the range that started at HK$12.25.

The final price values Sinopharm at 25.5 times its projected earnings for 2010, based on the syndicate consensus. With no direct comparables in the international markets - basically Sinopharm is growing at a much faster pace than similar companies in the US and Hong Kong-listed Guangzhou Pharmaceutical is a much smaller company with a market cap of just $850 million - investors were left to take their cue from the China-listed pharmaceutical distributors, which are trading at an average 2010 price-to-earnings ratio of 28 times. Since A-shares typically trade at much higher multiples than their H-share counterparts, the slight discount implied may actually suggest that Sinopharm is coming to market at quite a rich valuation. Not that this tend to matter in a market that is driven largely by liquidity, however.

Sinopharm is scheduled to start trading on September 23.

Before that, a series of other listing candidates will have priced their IPOs and we will have a clearer picture of whether investors remain selective in their investment choices, or whether Hong Kong is once again seeing the kind of indiscriminate buying of IPOs that was commonplace in 2007.

Sinopharm offered 545.679 million shares, which represented 25% of the company. There is also a 15% greenshoe that could increase the total deal size to as much as $1.3 billion and push Sinopharm ahead of aluminium extrusion company China Zhongwang Holdings, which raised $1.26 billion in early May and is currently the largest Hong Kong IPO this year.

Sinopharm is the largest distributor of pharmaceutical products in China with a market share of about 11% -- more than twice of the number two player. Other selling arguments included a combination of scale, high growth, and increased healthcare spending in China. The industry is also expected to consolidate along the lines of what has already been happening in Europe and the US.

Analysts note that healthcare spending account for only 4.5% of GDP in China, compared with 75% in the UK and more than 90% in the US, suggesting a lot of room for growth. Also, with regard to consolidation, the top three pharmaceutical distributors in China have a combined market share of only 20%, compared with a 64% market share for the top three players in Europe and 90% for the top three in the US.

The cornerstones, which took a combined 17.3% of the base deal, are: China Life, Bank of China Group Investments, China Construction Bank International, the Government of Singapore Investment Company (GIC), Martin Currie, Och-Ziff, Value Partners, David Li and a company called China Cheng Tong.

Separately, Digital China, a Hong Kong-listed computer distribution company that is 16%-owned by computer manufacturer Lenovo's parent company, completed a small top-up placement last night that was said to have received good demand from more than 50 investors. The price was fixed at the top of the HK$6.20 to HK$6.60 indicated range for a total deal size of HK$380.5 million ($49 million). The final price represented a 6.5% discount to yesterday's close of HK$7.06.

The deal, which was arranged by J.P. Morgan and Macquarie and accounted for about 6% of the existing share capital, was about one-third covered at launch by an anchor investor.