Fund managers have applauded the decision to bow to volatile global market conditions and price the 16.78 billion share offering for China Petroleum and Chemical Corp (Sinopec) just below the mid-point of the deal's indicative range. Confounding those who believed that Chinese officials would consider it a loss of face, the move also emphasises the government's determination to keep its huge privatisation programme rolling smoothly forwards.
As one London-based fund manager, who wished to remain anonymous, puts it, "We have been very encouraged that the Chinese government seems to have taken a long term view of the privatisation process. Acknowledging that there are plenty more deals to come and soon, it has left plenty of upside on the table for investors."
A New York-based fund manager, similarly requesting anonymity, adds, "The Chinese government has been very reasonable and we have been relatively impressed and surprised that they have taken such a responsible approach."
With Morgan Stanley Dean Witter and China International Corp as global co-ordinators, the deal closed yesterday (Thursday), with institutional books three times subscribed and retail books four times subscribed. Ranking second to China Unicom as the largest H share IPO on record, the deal raised $3.468 billion, representing 20% of the company's share capital.
Pricing came at HK$1.61 per share and $20.645 per ADS (where one unit equals 100 shares), compared to respective indicative ranges of HK$1.48 to HK$1.79 and $18.98 to $22.95. A further 1.258 billion shares are available as a greenshoe, representing another 3% of the company's share capital.
With the Hong Kong retail IPO constituting 5% of the offering rather than the usual 10%, 839 million shares will be placed to local investors. The international placement tranche has been split equally between institutions and a combined group of local Hong Kong corporates and four strategic investors constituting, Exxon Mobil, BP Amoco, Shell and ABB Asea Brown Boveri.
Alongside the two leads, BNP Prime Peregrine was joint-lead manager of the Asian tranche, with Dresdner Kleinwort Benson and ING Barings joint lead managers of the European tranche and Credit Suisse First Boston joint lead manager of the US tranche. Co-lead managers comprised CLSA, DBS and Jardine Fleming in Asia, ABN AMRO, Cazenove and CSFB in Europe and DLJ, Lehman Brothers and Merrill Lynch in the US. Bank of China International, HSBC and Jardine Fleming were also co-lead managers in the Hong Kong retail deal.
Gross fees total 2.5%, of which 1.625% derives from the selling concession, 0.5% from the management fee and 0.375% from the underwriting fee. The joint global co-ordinators and joint lead managers have also both taken a 25% praecipium from the management fee.
Observers report that a total of 450 accounts were represented in the final order book, with initial allocation splits indicating that demand was relatively even across the three regions, with Asia accounting for about 35%, the US a further 35% and Europe the remaining 30%.
Relative to Petrochina, against which Sinopec has been most closely judged, observers also say that the company has managed to achieve a premium even before an IPO discount is taken into account. Says one, "Most accounts have looked at this company on a price/earnings basis. Against 2000 earnings, Sinopec has come at a 43.4% premium and against 2001 earnings at a 1.9% premium. Sinopec has been priced on a price/earnings ratio of 8.2 times 2000 earnings, while consensus opinion puts Petrochina at a current trading level of 5.72 times 2000 earnings."
He adds, "During roadshows, it soon became quite obvious that investors think now is the right point of the cycle to move from an upstream play to a downstream play. Petrochina derives 80% of its operating income from exploration and production, which is very dependent on high oil prices, while Sinopec only derives 25% of its operating income from this source."
On an EV/EBITDA basis, one fund manager adds that according to his calculations, Sinopec has been priced at a slight discount, equating to a ratio of 4.3 times 2001 earinngs versus 4.4 times for Petrochina.
Since listing earlier this year, Petrochina has risen from an issue price of HK$1.28 to close yesterday at HK$1.66, a 29.6% increase, against a 6.925% year-to-date decline in the Hang Seng China Enterprises Index. With most of the price upswing fuelled by increasingly buoyant sentiment towards China's macro picture, Petrochina stands out as one of only a handful of primary issuers so far this year to have been able to hold onto any gains.
For bankers, it has been a case of watching investors move back into quality stocks with real earnings. As one argues, "People seem to overlook or forget the fact that Petrochina is not only the fourth largest oil producer in the world, but Asia's most profitable company as well. Net income is likely to total $7 billion this year, against $2.3 billion for Sinopec which is China's biggest revenue earner, but suffers from thinner margins because raw material costs are much higher."
"Still," he adds, "Sinopec's net profit is likely to record a threefold increase over the FY 1999 and going forwards, if oil prices moderate as people expect they will, then the company is likely to show better visibility of earnings than Petrochina."
Fund managers, however, agree that Petrochina is not a particularly valid comparison. "They really are very different beasts, although obviously they share the same restructuring story," says one US fund manager.
"We prefer to analyse Sinopec against its global peers and valued it against the super majors rather than other emerging market oil plays," he continues. "We looked at it on an EV to debt adjusted cash flow basis and calculated that at four times 2000 earnings, it is trading at half the levels of its peers."
"The fact that the three biggest oil major participated in the transaction is very meaningful and we believe that retail demand in China is almost completely untapped. We have a very bullish view of the company, but didn't participate in the offering in a particularly large way because we don't think this is how the market will view the company over the medium term."
Analysts, however, also agree that both Petrochina and Sinopec remain undervalued. Says one Hong Kong-based analyst, "People argue that emerging market companies should trade at lower multiples because the cost of capital is higher. But they forget that the super majors are often operating in alien environments such as Nigeria and Angola. Over a quarter of BP Amoco's production volume, for example, is derived from Alaska."
He argues that for Petrochina and Sinopec, both of which operate entirely in their home markets, the production cost per barrel is only $10 against a current Brent crude price per barrel of $31. "On top of this," he notes, "Petrochina has 15 billion barrels of proven reserves which are valued at only $2.80 on a ratio of EV/barrels. Petrobras, which is always considered the leading emerging market oil play, is trading at $5."
Fund managers conclude that Sinopec probably has about 30% of upside built into its launch price over the medium term. Yet looking forwards, both Sinopec and Petrochina are regarded as two of the best proxies of GDP growth and the underlying restructuring story which is propelling it. "When you consider that current inefficiencies have already been priced into the stock, then there can only be tremendous upside for those that believe in the restructuring story," one banker concludes.
