Huadian Fuxin Energy, the renewable energy arm of the China Huadian group, yesterday started the institutional bookbuilding for its Hong Kong initial public offering despite lingering uncertainty about Europe and the level of economic growth in China.
Reflecting the environment, the size of the offering has been reduced compared to earlier indications and the company is now aiming to raise between HK$2.4 billion and HK$2.64 billion ($309 million to $340 million). At the start of the investor education two weeks ago, bankers talked about a deal size of about $400 million to $600 million.
Its sector peers have had a mixed performance since then, so it is unclear whether Huadian Fuxin has had to ease back on its valuation expectations, but it has settled for selling just 20% of company. Initial assumptions had been for a deal size between 20% and 25%.
Huadian Fuxin has also secured demand for up to two-thirds of the base offering from cornerstone investors and bankers were said to have had good visibility on the rest of the deal prior to launch. In fact, subject to final confirmation on the day, the entire offering was basically covered before the order books even opened and sources said the bookrunners wouldn’t have gone ahead and launched the deal if they hadn’t been all but certain that it would clear.
Almost all of the cornerstone and anchor demand is coming from strategic or corporate investors, which is a clear indication of the continuing scepticism towards IPOs among financial investors. Their unwillingness to take on the additional market risk that comes with an IPO has already caused a number of Asian deals to be pulled or postponed in recent weeks. Graff Diamond’s $1 billion IPO was cancelled a day before pricing due to insufficient demand, and Formula One chose not to kick off the institutional bookbuilding as planned a week ago, but to continue the investor education for a bit longer in the hope that there will be a better window to launch in the near-term.
Inner Mongolia Yitai Coal, which started pre-marketing for a Hong Kong share offer of at least $1 billion at the same time as Huadian Fuxin, also decided not to start bookbuilding this week but to “continue to closely monitor the market” for the time being. Aside from the difficult market environment, the Chinese coal producer is facing an additional challenge in that it already has US dollar-denominated B-shares listed in Shanghai, which are currently trading below the floor price that it has to adhere to. The floor price is equal to the 20-day moving average price of the B-share on April 11, the day the IPO received regulatory approval.
There has been a lot of discussion about whether placing most of a deal with cornerstones and anchors is the right thing to do — especially when most of that demand comes from corporate-type accounts — as it could make the stock highly illiquid after listing. However, for many mid-sized Chinese companies that is the only way to get a deal done at the moment. And one source argued last week that it is even good for the market that there are alternative sources of demand. To some extent, the involvement of strategic investors is also in indication that companies with links either to the industry or the issuer itself believe in the business and the future outlook.
Huadian Fuxin has secured six cornerstone investors, which have committed to buying $208.8 million worth of shares, which is equal to 61.4% to 67.6% of the base deal depending on the final price. According to sources, the two biggest cornerstones are Sinovel Wind Group, a wind turbine maker, which will buy $58.8 million of shares, and CSR Zhuzhou Electric Locomotive Research Institute, a unit of Hong Kong-listed train manufacturer CSR Corp (formerly known as China South Locomotive & Rolling Stock Corp), which is taking $50 million worth.
Also coming in as cornerstones are Huaneng Renewables, Shanxi Lu’An Mining, and State Grid Corp, which are investing $30 million each, and a unit of GE Capital, that is putting in $10 million.
Huadian Fuxin is offering 1.5 billion shares at a price between HK$1.60 and HK$1.76 apiece. As usual, 90% of the shares will be targeted at institutions, while 10% has been earmarked for Hong Kong retail investors. The final split is subject to standard clawback triggers. The deal comes with a 15% greenshoe that could increase the maximum proceeds to $391 million.
The price range values the company at a 2012 price-to-book multiple of 0.89 to 0.97 times, and at a price-to-earnings ratio of 7.6 to 8.4 times, based on the joint bookrunner consensus. Given the asset-heavy nature of the company and the ongoing build-out of the business, most people are expected to look at the P/B multiples, which pitch the company at a premium to Huaneng Renewables and China Datang Corporation Renewable Power, currently quoted at 2012 P/B multiples of 0.7 and 0.6 times respectively. China Longyuan Power Group, which is the largest wind power producer in China, is trading at one times book.
Huadian Fuxin is looking a bit pricey versus Huaneng Renewables and Datang Renewable on a P/E basis as well, as the latter two are currently quoted at 5.9 times and 6.3 times, respectively. Longyuan Power is quoted at 10.2 times after gaining 14.9% since the first day of premarketing for Huadian Fuxin.
One thing that could work in Huadian Fuxin’s favour is that it has a more diverse business model than the other three, which focus primarily on wind power. At the end of 2011, Huadian Fuxin’s generating capacity was divided between hydro-power (2.2 gigawatt), wind power (2.2GW), thermal coal plants (2GW) and others, which include solar power and a nuclear power plant that is under development (80 megawatt).
Investors tend to like hydropower in particular, as it is quite stable. On the other hand, the fact that it owns four coal-fired power plants (plus another two under construction) means that Huadian Fuxin isn’t really a pure clean energy company, although it does describe itself as such, and that means that some clean energy and corporate social responsibility (CSR) funds will not be able to invest in the stock.
However, the company notes in the preliminary listing prospectus that both its hydropower and coal-fired power businesses have generated significant revenues and cash flow to support the development of its clean energy projects. The company says that going forward it will focus primarily on the expansion of its hydropower and wind power capacity, which has significantly wider margins than its other businesses. It has already secured the rights to develop new wind power projects in 21 provinces in China with an estimated combined installed capacity of 40,000MW, including 1,000MW that is expected to be completed during the remainder of this year.
Other key selling points are the government’s support of clean energy businesses and the fact that its parent company has a number of energy projects that may eventually be injected into the listed unit — although, the same can be said of its three competitors. There is also a risk that the state support for wind power and other clean energy projects may ease in the future.
Huadian Fuxin has grown its portfolio of power generating assets quite significantly in the past three years, which has left it with Rmb21.7 billion ($3.4 billion) of long-term debt and a gearing ratio of 316% as of the end of last year. The company said it expects to continue to rely on bank loans to fund its expansion going forward, although part of the IPO proceeds will go towards the construction of clean energy projects and to buy wind and gas turbines. It will also pay off some short-term borrowings.
According to the prospectus, it expects to incur Rmb20.3 billion of capital expenditures in 2012 and 2013 combined and invest approximately Rmb800 million into the Fuqing Nuclear Power Plant in each of 2012, 2013 and 2014.
In 2011, the company posted a decline in net profit to Rmb638.5 million from Rmb798.1 million in 2010 as revenues fell by close to 15% to Rmb7.15 billion. However, the adjusted operating margin widened slightly to 22.7% from 20.3% as a higher proportion of the earnings came from the wind power segment and improved profit margins in the coal-fired business due to higher utilisation hours at one of its plants.
Huadian Fuxin is 85.8% owned by the Huadian Group, which is one of China’s big five power producers. The rest is owned by a group of Chinese pre-IPO investors.
The institutional order book will remain open until next Tuesday (June 19) and the price is expected to be fixed after the US close that day. The trading debut is scheduled for June 28.
Bank of America Merrill Lynch, Citic Securities, CLSA and UBS are joint bookrunners.
