Assuming a favourable outcome from the vote, DCH will be looking to raise between HK$3.55 billion and HK$4.6 billion ($455 million to $589 million) and will kick off the retail portion of its offering on Thursday. The trading debut is scheduled for October 17.
The offering marks the second time in six months that the Hong Kong-listed conglomerate conducts a public offering for one of its units as it seeks to divest non-core operations to realise cash for other parts of its business, including the property and specialty steel divisions. In March the company reduced its stake in Citic 1616 from 100% to 50.1% through a $270 million IPO. Citic 1616 is a telecom hub operator that connects voice and data services providers in Hong Kong and China with operators in 50 other countries.
Investors are expected to vote in favour of the spin-off as it will help realise hidden value at DCH and also provide the unit with some fresh capital to fund its planned expansion. After the IPO, DCH will also have the possibility of accessing the capital markets on its own account to raise additional funds. Shareholders of Citic Pacific will be able to participate in the IPO through a preferential share offering, although the disappointing performance of Citic 1616 since its trading debut on April 2 may make some investors think twice before buying into DCH as well.
The listing candidate, which has operations in Hong Kong, Macau and China, is offering 781.2 million shares at a price between HK$4.55 and HK$5.88. About 180 million of the shares, or 23%, are new. The remaining 601.2 million are existing shares that will be sold by Citic Pacific, which will see its stake diluted to 56.6% after the IPO. If the 15% greenshoe is also exercised in full, its holdings will fall further to 50.1% and the maximum deal size will increase to as much as $677 million.
The offering is arranged by BNP Paribas and will be by far the largest Hong Kong IPO the bank has worked on this year. BNP also acted as the sole bookrunner on a $152 million offering for optical components manufacturer Sunny Optical and on a $122 million offering for specialty steel manufacturer Tiangong International, as well as on Citic 1616Æs offering.
As usual, 10% of the deal will be earmarked for Hong Kong retail investors, although standard clawback triggers apply and could see this tranche increase to as much as 50% in case of strong retail demand. In addition, 5.7% of the deal has been set aside for the preferential offering to Citic Pacific shareholders, who can subscribe to one DCH share for every 25 Citic Pacific shares they own.
Like most other Hong Kong IPOs as the moment, the deal will also have a cornerstone tranche, which will account for between 17.8% and 23% of the total offer pre-greenshoe depending on the final price. This will leave between 61.3% and 66.5% of the deal for institutional investors.
The cornerstones include Li Ka-shing, Henderson Land Development chairman Lee Shau Kee, and New World Development chairman Chen Yu-tung, who will each invest $30 million. Otsuka Pharmaceutical, a branded beverage and pharmaceutical products maker which is a strategic partner of DCH, rounds off the $105 million cornerstone tranche with a commitment to buy $15 million worth of shares.
The key reason to invest in DCH is the companyÆs aim to continue to expand its operations in China. According to investors who have met with the company since the roadshow institutional roadshow kicked off last Tuesday, the portion of revenues derived from China is forecast to increase to 55% in 2009 from 43% in 2006. Despite the slightly lower margins on the Chinese businesses, this should become a major driver of bottom-line growth and the recurring net profit is expected to grow at a compound annual growth rate of about 25% in 2006-2009, they say.
A Hong Kong-based analyst who follows Citic Pacific said he doubted there would be that much growth potential, seeing as DCH is just a trader and distributor of goods that other companies produce and yet others sell on to the end-consumer. Also, it typically doesnÆt have exclusive distribution rights to these products.
ôThis is not a secular growth story and I cannot imagine it will be able to achieve 20%-30% growth, even 10%-15% is generous,ö the analyst says. ôCitic Pacific has been successful at restructuring itself, but it needs more catalysts to justify its current valuation and I donÆt think this is really what people are looking for.ö
In 2006 DCH posted a net profit of HK$322 million and a recurring net profit of HK$292 million after deducting valuation gains on investment properties and a loss from its engineering business that has since been discontinued.
The bulk of the companyÆs earnings come from the auto distribution business, which accounted for 59% of its total revenues in 2006. The food and consumer trading and distribution business accounted for 39% and the logistics business for 1%. The latter provides a wide range of supply chain solutions, including the transport and storage of frozen and chilled products, to third party customers and is expected to account for a slightly bigger portion of revenues and profits going forward. Its customers include The Venetian Macau Resort Hotel, Wynn Macau Resorts and Unilever.
DCH has been selling cars in Hong Kong for more than 40 years and has a 27% market share of the new vehicle market. It moved into the Chinese market in 1979 and currently distributes 17 brands of imported or locally produced vehicles, including Bentley, Hyundai, Honda and Toyota.
Sales are expected to be underpinned by the fact that China still has a very low penetration rate in terms of car ownership with only 28 of every 1,000 people having a car. This compares with 55 people in Thailand, 95 in Brazil, 210 in Russia, 238 in South Korea and 449 in Japan. The car sales industry in China is also very fragmented, with its long experience, long-term relationships with global car manufacturers and sufficient capital support from its parent, DCH should benefit from the expected consolidation.
DCH also supplies more than 500 different food products and 70 brands of so called ôfast moving consumer goodsö to shops and restaurants in Hong Kong and Macau, including well-known brands like Twinings tea, Pocari Sweat, Ovaltine, and Barilla pasta. It also operates 52 retail outlets in Hong Kong under the DCH Food Mart name, which focuses primarily on frozen foods, and plans to open 18 more in the next three years, including eight deluxe versions. In China, it currently distributes about 150 different food products, but observers say there should be significant upside potential here as ChinaÆs young generation has more spending power and is also more keen to buy foreign-branded products.
The final price values DCH at about 16 to 20 times its projected 2008 earnings, according to sources. This puts it at a discount of up to 54% versus China Resources Enterprises (CRE), a conglomerate that some analysts view as a reasonable comparable given it is also active within trading and retail businesses. However, CREÆs retail business is significantly larger than that of DCH, which means a sizeable discount is warranted.
Other comparisons include the Chinese supermarket stocks, which according to Bloomberg data trade at an average 2008 price-to-earnings multiple of 25.8 times, and the food and beverage producers at an average 33.6 times. On the auto distribution side, the key counterparts are seen to be Jardine Cycle & Carriage, which is owned by the Jardine Matheson group and listed in Singapore, and Malaysia-listed Sime Darby, which derives about 30% of its revenues from the distribution of motor vehicles in Malaysia, Singapore, Hong Kong and China.
Cycle & Carriage, which distributes cars in Indonesia, Singapore and Malaysia, currently trades at a 2008 P/E multiple of 12, although syndicate analysts argue that this needs to be adjusted to take into account that Hong Kong-listed companies tend to trade at a premium to their Singapore counterparts due to greater liquidity. The adjusted P/E will be closer to 20 times, they say. Sime Darby is quoted at a 2008 P/E ratio of 18 times.
According to a circular issued by Citic Pacific, DCH will spend about 46% of the net proceeds to expand its motor vehicle business and sources say it plans to open six dealerships in China per year for the next three years. Another 23% will go towards the food and consumer products business, while 30% will be set aside for the logistics business. The remaining 10% will be used as general working capital.
Citic 1616, which was marketed as a play on ChinaÆs growing cross-border telecom traffic, surged 67% on its first day of trading to HK$4.31 and reached a record close of HK$4.39 the following day, but since then it has been on a primarily declining trend. On Friday it closed three cents below its IPO price at HK$2.55. In the same period, Citic Pacific has gained 71% and on September 29 closed at its highest level in seven and a half years.
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