Air China priced its Hong Kong and London IPO yesterday (December 9), raising HK$8.36 billion ($1.08 billion) pre greenshoe from the CICC and Merrill Lynch led deal. The 2.805 billion share offering was priced at HK$2.98, representing a 4% discount to the top end of a HK$2.35 to HK$3.10 indicative range.
The company and its lead managers appear to have taken a sensible approach to pricing, recognizing that bullish sentiment in the Hong Kong IPO market is currently being driven by liquidity rather than fundamentals. As such, Air China decided to give investors a small secondary market kicker despite the fact that the institutional order book closed 45 times covered and the retail order book 83 times covered.
The likelihood of secondary market performance has also been underpinned by the way the institutional portion of the deal has been squeezed by retail clawbacks and Cathay Pacific, which is taking a 9.9% strategic stake in the company through the IPO. Hong Kong's national carrier is taking 33% of the overall offering at the IPO price.
An additional 4% was placed into a POWL (Public Offering Without Listing) in Japan run by Daiwa SMBC. This was originally expected to be 10%.
About 400 institutional accounts are said to have placed orders, with well over 90% showing no price sensitivity at all. About 15 accounts placed orders for more than $100 million.
The lack of price sensitivity at the end of the IPO process contrasts to initial pre-marketing feedback, which suggested accounts believed the airline was fully valued at the top end of the price range. At HK$2.98, Air China has been priced at 11.5 times 2005 earnings and 1.39 times price to book according to syndicate research.
At this level it has come at a premium to China Eastern, which had been expected and also potentially to China Southern, which had not. According to syndicate research, China Eastern is currently trading at 11.5 times 2005 earnings and China Southern at 16 times.
However, non syndicate houses tend to value both airlines at lower levels, with China Eastern trading in a 8.5 to 10 times band and China Southern at 10 to 11 times. On a price to book basis, the two listed Chinese carriers are also cheaper, with China Eastern trading at 1.2 times book and China Southern at book value.
Lead managers have argued that Air China deserves a premium because of its growth profile and the quality of its earnings, with ROE pushing up towards 25%.
As one specialist comments, "What sells well from China at the moment are domestic consumption stories and Air China is a perfect proxy. The domestic airline market is growing strongly and it's protected from competition. There are no low cost carriers and the only routes being opened to foreign carriers are international ones."
According to the CAAC (China Aviation Authority), the Mainland registered 50% year-on-year growth in terms of airline passengers through to the end of September (90 million passengers). It also estimates that the market will continue to grow by more than 10% over the next decade, double the global average.
The sector's long term growth combined with the comfort factor of Cathay's stake and market momentum have propelled Air China's IPO to a very strong finish. In the process, investors appear to have ignored China Eastern's recent air crash, the potential demise of China Aviation (which has a monopolistic grip over the carriers' jet fuel) and the impact of high oil prices on Air China's profit figures.
Non syndicate analysts believe the biggest determinant of Air China's performance in 2005 will be oil prices. Because the carrier has a higher ratio of fuel costs to operating costs than both China Eastern and Southern (35% versus 25% for the other two) it is far more sensitive to movements either way. It is estimated that every $1 movement in oil prices will increase or reduce Air China's net profit by $13 million.