State-owned power generation enterprise China Datang Group could not have started premarketing the initial public offering of Datang Environment Industry, its environmental protection and energy conservation business, at a better time.
Since November 30, leaders of major economies and environmental specialists have gathered in Paris for the United Nations Conference on Climate Change in an attempt to finalize an agreement to limit greenhouse gas emissions.
The topic coincidentally matches with Datang Environment’s main business of desulfurization and denitrification – processes that allow coal-fired power generators to reduce emissions of sulfur dioxide and nitrate gases.
China is the biggest energy-consuming nation in the world. It is also a major emitter of greenhouse gas, partly because of the massive use of coal for power generation. About 78% of the country’s electricity was produced from coal-fired power plants in 2014, according to the National Bureau of Statistics.
As China’s economy grows it is facing mounting international pressure to tackle climate change by setting limits on its carbon and greenhouse gas emissions.
Environmental protection has become one of the country's top priorities since 2014 after Chinese Premier Li Keqiang “declared war on pollution” and pledged to tackle environmental issues during the opening session of the National People’s Congress.
Those ideas were echoed by Chinese President Xi Jinping, who called for global efforts to address climate change and pursue sustainable development during his opening speech at the Paris climate conference on Monday.
Datang Environment can ride on the environmental protection-related policies as its business aligns perfectly with them.
Last year, the company earned its largest revenue from the engineering business, which helps power generators and industrial companies construct environmental-friendly facilities to reduce carbon emissions.
Those facilities include desulfurization, denitrification, dust removal, ash and slag handling and industrial site dust management, according to the company’s preliminary prospectus. The business accounted for 59% of total revenue last year and 43% in the first six months of this year.
Concession operation is another important piece of business for Datang Environment, with a revenue contribution of 38.5% in the first half from 24% last year. Through the concession operation model, Datang Environment acts as a contractor to help power producers accomplish gas emission targets, and in return it gets a share of the benefits the power producers receive from the government.
Through such agreements the two parties create a win-win situation. Datang Environment is able to share a slice of the country’s environmental protection subsidies, while power producers are able to fulfill emissions targets set out by environmental regulators.
Syndicate analysts are predicting a compound annual growth rate of 31% for the company’s net profit between 2015 and 2017, mainly driven by rapid expansion of the concession operation business.
Valuation
The absence of similar business in Hong Kong-listed companies means it is not easy to come up with a fair value for the business. In addition, air pollution treatment companies trading in Shanghai and Shenzhen have fairly diverse valuations from 15.5 times to 45.5 times forecast 2016 earnings, making fair value estimates much more difficult.
Thus, banks running the deal have a wide fair value range from $2 billion to as much as $3.1 billion, which is roughly 14 times to 20 times Datang Environment’s consensus earnings estimates next year.
After applying a market average A/H discount of 36%, China-listed air pollution treatment companies trade at 19.5 times forecast 2016 earnings on average, which is in line with Datang Environment’s fair value at the highest end.
By comparison, the group’s core power generation unit Datang International Power trades at 5.8 times earnings on a rolling 12-month basis in Hong Kong, while its wind power unit China Datang Corporation Renewable Power trades at 13.2 times earnings.
Datang Environment intends to use the IPO proceeds to expand its operational facilities, repay bank loans and for research and development and working capital purposes.
Tentatively, premarketing is expected to run until December 10, followed by a global management roadshow from December 10 to December 15. The company is scheduled to list on December 22.
Morgan Stanley and Citic CLSA are joint sponsors on the IPO.
