Another unique Chinese IPO opens in the US

Insurance agency CNinsure seeks to raise up to $150 million by offering investors exposure to a "new" high-growth industry.
Hot on the heels of China Digital TVÆs spectacular debut on Nasdaq two weeks ago comes another Chinese company offering unique exposure to a fast-growing industry. This time the focus is on the insurance agency and brokerage industry, which is expected to benefit from a projected compound annual growth rate of 150% in life insurance commissions in 2006-2009 and 55% growth of commissions from the non-life segment of the market.

Like China Digital TV, CNinsure Inc has a business model that is similar to that of its peers in the UK and the US û and therefore familiar to investors in that part of the world. But instead of the stagnant, mature markets of the West, it operates in a relatively young and underpenetrated market, which suggests high-growth opportunities as China's economy continues to expand and its middle class gets increasingly larger and more affluent.

The listing candidate distributes insurance policies issued by ChinaÆs largest insurance companies as well as several international companies operating in China through 17 of its 21 affiliated insurance intermediaries. The other four are insurance brokerages which sources insurance products from various insurance companies on behalf of its retail or corporate clients. The company, which earns most of its revenues from commissions and fees from the insurance companies, started off in 1999 as a distributor of auto insurance, but in 2002 it expanded into property and casualty insurance and in January 2006 it also began to distribute life insurance products. About 75% of its revenues come from policies sold to retail clients.

Several other Chinese companies that have listed in the US over the past couple of years have been snapped up by investors on the back of similar characteristics and because they offer a unique way to play the China growth story. These include drug research and development outsourcing company WuXi PharmaTech and real estate brokerage firm e-House Holdings, which both listed on the New York Stock Exchange in early August as the first Mainland firms in their respective industries to seek a listing outside of China. Wuxi currently trades 143% above its IPO price of $14, while e-House has gained 98% from its listing at $13.80.

China Digital TV, which provides connectivity access software and smartcards for digital TV systems, soared 219% in the first two days after its October 8 debut, pushing its projected price-to-earnings valuations to a staggering 82 times. As the US markets have become more jittery, however, it has shed about 21% over the past four sessions and on Friday closed at $39.51. While well below its closing high of $51.08 it is still 147% above the IPO price of $16.

No doubt, investors will be hoping for a similar share price development for CNinsure, which is being brought to market by Morgan Stanley.

The listing candidate is offering 26.5% of its share capital in the form of 11.6 million American Depositary shares. The price range has been set at $11 to $13 per share, which suggests a total deal size between $127.6 million and $150.8 million and a market capitalisation at the time of listing of $509 million to $601 million. There is also the usual 15% overallotment option, which could boost total proceeds to as much as $174 million.

Eighty-three percent of the base offering, or 9.65 million shares, are new shares. The remaining 17% will be sold by existing shareholders, including Lai Qiuping, president of CNinsure and one of its two founders. Nowadays he plays a quite passive role with regard to the day-to-day operations, however. The overallotment option is made up of all new shares.

According to a source, the price range values the company at 20.9 times to 24.4 times, which at the low end indicates a premium of about 30%-40% over US and UK peers such as Marsh & McLennan, Aeon Insurance Group, Willis Group Holdings and Arthur J Gallagher & Co, which trade at an average 2008 P/E multiple of around 15. This premium should be warranted, they say, because of CNinsureÆs much stronger growth profile which is supported by a much lower insurance penetration rate than in the West. The company notes in its listing prospectus that only 1.7% of the Chinese population has life insurance, compared with 4.8% in the US. The use of non-life insurance is even lower at 1%, versus 4% in the US.

The insurance agency industry is also growing rapidly as more and more insurance companies choose to outsource their distribution in order to focus on their core underwriting business. For international insurance companies that are trying to break into the Chinese market but lack a sales network of their own, outsourcing of the distribution is the quickest way to penetrate the market. Total insurance premiums generated by insurance agencies grew by 91% in 2005, by 22% in 2006 and by 44% in the 12 months to June 2007. The growth rates recorded in those same periods by the insurance brokerage industry were 36% in 2005, 6% in 2006 and 21.4% in the 12 months to June 2007.

Meanwhile, the Chinese insurance companies are setting a valuation benchmark at the upper end with PICC Property & Casualty, Ping An Insurance and China Life Insurance trading at about 40 times their projected 2008 earnings. Their much larger scale and the fact that they are able to benefit from the entire premium income, rather than having to rely on commissions, are key factors for their higher valuation. At the same time, however, CNinsure doesnÆt have to bear any of the underwriting risks as it is only selling policies issued by other parties.

The third group of comparables, according to the source, are other US-listed, China-based high-growth companies, including the earlier mentioned China Digital TV, WuXi Pharmatech and e-House, which were initially brought to market at forward P/Es of around 25-30 times, but now trade at an average of 40-42 times. These are comparable not from a business point of view, but from a technical perspective.

ôTheir premiums represent the market leadership that they have and the growth potential in the Chinese market, which are two things that this company has going for it as well,ö the source says. Despite the strong share price development of their predecessors, newcomers will still have to offer a healthy discount to the existing high-growth stocks, however.

Aside from the organic growth potential, CNinsure is aiming to aggressively expand its distribution network through acquisitions, taking advantage of the fact that the insurance agency industry is highly fragmented. It will set aside up to $60 million of the net IPO proceeds for acquisitions and the formation of new agency joint ventures. At present, China's top ranked insurance agency has a market share of only 3.7%, followed by the second largest with 2.7%. The third largest, which is affiliated with CNinsure has a 2.5% share of the market. According to data provided by China Insurance Regulatory Commission, three other CNinsure affiliates are ranked number 11, 14 and 20 among the countryÆs top 20 insurance agencies in terms of revenues, with an accumulated 4.9% market share.

While this fragmented a market clearly points to consolidation opportunities, it also indicates that the barriers to entry are very low and that the industry is highly competitive. If the company fails to carry out its acquisition plans, this could end up hampering its growth opportunities. Another risk for investors to consider is the companyÆs short operating history within life insurance, which is the segment of the market that is currently showing the fastest growth. Still, commissions earned from life insurance products accounted for only 8.4% of the listing candidateÆs total commissions and fees in 2006 and 11.3% in the first half of 2007.

In the prospectus, the company says that it has made the distribution of life insurance products one of the focuses of its growth strategy. However, it then adds that if this business fails to grow successfully the companyÆs ôfuture growth will be significantly affected.ö

Syndicate analysts project the company will see revenue growth of 75% this year and about 90% in 2008, which should result in a net income CAGR of 60% in 2006-2009. However, net income growth will fall to about 27% next year from over 100% this year as the company will begin to pay a 25% tax rate, having paid close to zero in the past few years.

Between 2004 and 2006, CNinsure recorded a revenue CAGR of 169% resulting in a top line income of Rmb246.5 million ($32.4 million) last year. In 2004 and 2005 it reported a net loss, but this reversed to a net profit of Rmb57.4 million in 2006 and Rmb58.7 million ($7.7 million) in the first half 2007.

The company kicked off its roadshow last Thursday. It will set the final price on October 30 and will start trading on October 31.
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