Roadshows for a $150 million to $170 million IPO for Red Chip China Guofeng will begin today (Monday) following two weeks of pre-marketing. Pricing will take place on the weekend of December 11/12 with First Shanghai and Macquarie acting as co-leads alongside lead manager JPMorgan.
The deal marks the second IPO lead manager JPMorgan has completed for a Chinese steel company this year and its prospective valuation shows just how hard the sector has been hurt by the government's austerity measures.
The company will have a freefloat of 25% pre greenshoe and is marketing the deal on a 2004 P/E range of 4.5 to 5 times forecast earnings of Rmb1.1 billion ($135 million) and 3.3 to 3.7 times 2005 forecast earnings of Rmb1.47 billion ($179 million). By contrast, its most immediate predecessor, China Oriental, is trading at roughly 4.6 times 2004 earnings and 5.1 times 2005 earnings.
This means China Guofeng is being marketed at a 28% to 36% discount to China Oriental on a 2005 basis. Both companies operate at the low end of the steel sector producing billets and strips.
At IPO, China Oriental priced a 700 million share offering via JPMorgan and Merrill Lynch at HK$2.75, representing a forward (2004) P/E multiple of 6.1 times. The deal was priced in late February catching the peak of the last cycle and has since traded down 48%, closing Thursday at HK$1.47.
When it was priced, China Oriental came at a 25% discount to the 8.3 times average of the big three Chinese steel manufacturers - Angang New Steel, Chongqing Iron & Steel and Maanshan Iron & Steel. Specialists say that Maanshan is the best comparable since it is the largest producer of long steel products, which like billets and strips are primarily used in the construction industry.
Maanshan is currently trading on a range of 6 to 8.8 times 2005 earnings. At the mid point of this range, China Guofeng is being pitched at a hefty 48% to 53% discount.
Aside from its cheaper valuation, lead managers are also attempting to entice investors with an attractive dividend yield. This will come out at 7.8% to 8.2% compared to Maanshan's 5.64% forward yield.
As one observer puts it, "This deal needs to be attractive because hard landing fears in China have a direct impact on the steel sector. There's also a lot of uncertainty about global steel prices. Talk to five investors and they're all likely to give you divergent views over whether to buy into the sector now or later. Some believe the cycle is looking toppy again."
Maanshan is now up 38% since its year-to-date low of HK$1.76 in mid-May. However, it is still down 28% from its high in early April, when it hit HK$3.95 on April 8. The stock then plummeted 55% in the space of a month after the market became gripped by hard landing fears and domestic steel prices collapsed.
Analysts say China moved from being a net importer of steel to a net exporter as a result of the government's clampdown, which primarily affected the expansion plans of the SOE sector. In January 2004, for example, China was still importing 400,000 tonnes a month, which peaked at 600,000 in March. Come September, it was exporting 550,000.
Analysts say that strong imports were driven by a combination of strong domestic demand and inadequate supply. The situation flipped over as the austerity programme kicked in, but strong global steel prices have meant that increasing supply can be soaked up by exports.
However, they also point out that there is a big difference between the volatility of long steel prices (for products used in the construction industry) and flat steel prices for products, which have much wider uses in the white goods and shipping industries as well.
China Guofeng's profitability has also been hit this year because of inventory management issues and the syndicate is consequently forecasting a big 35% increase in profitability during 2005 after this situation is resolved. "The company reported a loss during the second quarter because coke prices suddenly appreciated and it was holding three months worth of inventory on its books that it then had to write it down. This shouldn't happen again, because it will hold just one month's worth of inventory."
They also point out that whereas leading regional steel companies like Posco and Taiwan's China Steel can lock in one-year contracts with coke producers, Chinese steel companies have to purchase it on the spot market and prices have risen 70% so far this year.
China Guofeng is using the majority of proceeds to move up the value chain into hot-rolled steel. During 2004, it has forecast capacity of 4.4 million of which the majority comes from strips - 2 million - where it has a 7.8% market share in China.
It also produces 1.13 million billets and 0.8 rebars. These all rank among the first products produced from iron in the steel manufacturing chain.
By the end of 2005, it hopes to add 1.2 million capacity from higher margin, hot rolled coil. By contrast, China Oriental has capacity of 3.25 million and Maanshan 8 million.
One of the reasons why China Oriental has performed so badly is that it announced plans to move into H-section steel and then had to cancel them after the austerity measures started to bite. Some specialists also say that the company has done an extremely poor IR job since the IPO, adding further weight to those who believe that smaller Chinese companies need a greater IPO discount because they lack transparency and consistency.
Of the three, China Oriental is currently the lowest cost producer with a production cost per tonne of Rmb1,671 compared to Rmb1,944 for China Guofeng and Rmb2,108 for Maanshan.
Guofeng's market price per tonne has hit Rmb2,900 per tonne during the fourth quarter, but the syndicate are forecasting that this will fall 5% to Rmb2,750 in 2005 and Rmb2,600 in 2006.
In terms of efficiency, Guofeng is said to score more highly than the other two. It has a current net investment cost per tonne of Rmb541 compared to Rmb626 for China Oriental and Rmb2,047 for Maanshan.
In the 2004 Financial Year, it is forecast to run a net margin of 10% rising to 12% in 2005. The company is 51% owned by Hong Kong listed China Travel Holdings.
