Bank of China launches highly anticipated IPO

With the exercise of the greenshoe the offer could raise up to $11.4 billion in an offering which could surpass China Construction Bank as largest ever equity deal from China.
When Bank of China kicks off the roadshow for its highly anticipated initial public offering today it will write another chapter in a turnaround story which has included massive bad loan write-offs, a $22.5 billion cash injection from the government and battles against management corruption at the highest level.

The result is a slimmer and more disciplined bank with a total asset value of Rmb4.74 trillion ($591 billion), a projected bottom line growth rate of 30% and an official sponsorship for the 2008 Olympic Games on its CV.

Like China Construction Bank before it, BOC is poised to attract the attention not only of Hong Kong investors, but of portfolio managers globally û at least for the next three weeks until its trading debut on June 1. And deeming from the inflow of capital to Hong Kong over the past week, overseas investors are preparing themselves.

According to sources familiar with the offering, ChinaÆs second largest bank by assets will sell 10.5% of its enlarged share capital, or 25.6 billion new H shares, which at the indicated price range will result in a base deal size between $8.2 billion and $9.9 billion. There is also a 15% greenshoe that could boost the total proceeds to a maximum $11.4 billion.

The IPO is jointly arranged by Bank of China International, Goldman Sachs and UBS.

If the offer is priced at the top end of the range or the greenshoe is exercised, the deal could surpass China Construction BankÆs $9.2 billion IPO in terms of size and make it the largest equity offering ever out of China.

The price range has been set at HK$2.50 to HK$3, which will value the company at about 1.9 to 2.2 times its post-money 2006 book value. That compares with about 2.6 times for China Construction Bank.

Like for other large-size offerings, the bank has secured a waiver from the stock exchange that allows it to reduce the retail tranche to 5% of the total offering from the normal 10%. In case of strong demand it can be increased to a maximum 20%. A yet to be determined portion of the offer will be sold to Japanese retail investor through a public offering without listing (POWL).

Following strong demand from corporate and high net worth individual investors, Bank of China has decided to allocate $2.26 billion worth of shares to 12 strategic investors, including mainland insurers Ping An Insurance and China Life Insurance and JapanÆs Mitsubishi UFJ Financial Group. Li Ka-shingÆs Hutchison Whampoa and Cheung Kong (Holdings) as one unit will also receive a guaranteed allocation in return for a 12 month lockup, as will Henderson Land DevelopmentÆs Chairman Lee Shau-kee and Chow Tai Fook, which is controlled by New World Development Chairman Cheng Yu-tung.

According to sources, all the strategic investors will buy $180 million worth of shares, except for China Life which will receive a slightly greater allocation due to a strategic alliance with BOC and one investor who will buy $160 million worth of stock. At the mid-point of the price range, the strategic investors will jointly buy about 25% of the offering.

A consortium led by Royal Bank of Scotland, which holds a combined 9.6% stake in BOC after a $3.1 billion investment last year, has decided not to exercise an anti-dilution option which would have allowed it to buy shares in the IPO to keep its existing stake intact.

ôRBS has a strategic cooperation with BOC within several areas like credit cards, wealth management and risk management and they are increasing their exposure in terms of management time, product focus and so forth, which is much more meaningful to the BOC story than to buy more stock,ö one source says. And even though the percentage RBS holds in BOC will fall slightly as a result of the new share issue, its dollar exposure will stay the same, he adds.

Other pre-IPO investors include Singapore government investment arm Temasek and ChinaÆs National Social Security Fund, which each have a 5% stake.

Invariably, investors will be comparing the newcomer to already listed CCB or Bank of Communications and will be asking themselves how the newcomer will be able to compete. The key thing here, according to people familiar with BOC, is the greater diversification of its business, which stems from its roots as ChinaÆs foreign exchange bank.

This has given it a solid client base not only among big Chinese corporates and multinationals, but also among the more affluent part of the mass consumer market. The latter category is a key development group for ChinaÆs still fledgling market for mortgages, auto loans and credit cards.

In 2005, BOC had the largest proportion of foreign currency loans (as a percentage of total loans) among the mainland banks with 34%, the largest proportion of retail loans with 23.4% and the largest contribution from Hong Kong and overseas loans with 15.9%. The contribution of non-interest income to its total revenue stream is also the highest in the industry at just above 19%.

The bankÆs focus on the affluent part of the consumer market led to a CAGR of 34% in mortgage loans and 22% growth in total consumer loans between 2003 and 2005. Consumer deposits grew at a 27% rate in the same period. As of the end of 2005, consumer loans accounted for 21% of BOCÆs total loans within its domestic operations, compared with 18.5% for CCB, while consumer deposits made up 57.5% of BOCÆs assets and 47.4% of CCBÆs.

Quite noticeably though, BOCÆs total loan growth of 4.1% last year was less than half of CCBÆs 10.4% growth and BocomÆs hefty 20.5%. One source argues that this was partly the result of BOCÆs aggressive focus on risk management reform and its aim to ensure a high asset quality.

ôYou can say that this bank is disciplined and has high quality with sustainable growth,ö the source says, adding that the lower loan growth makes the bank less exposed to economic cycles.

However, BOC also had a higher ratio of non-performing loans to total loans than its peers last year at about 4.6%.

According to the source, BOC has for reasons - mainly to do with regulatory guidelines - been able to write-off fewer bad loans in the past year. At the same time though, it has the highest impaired loan coverage ratio in the industry at 75-80% and in terms of impaired loans that are not covered by reserves, those are acutally in line or below its peers, he says.

Aside from loan growth, other key earnings drivers that will be highlighted by the syndicate include anticipated margin gains from higher asset yields, a better mixture of funding costs and an increasing loan deposit spread; a secular rise in the foreign exchange spread and rising fee incomes from FX trading and the potential for a lower income tax rate.

In 2005, the bank posted a net interest income of about Rmb100 billion ($12.5 billion) and a net profit of Rmb26 billion ($3.24 billion). Based on syndicate projections, the profit is expected to increase to at least Rmb33 billion in 2006.

The bank expects to build on its existing high-end client base of Chinese corporates going outside the mainland and international companies doing business in China. These also tend to be the type of clients which require more fee-based services and more sophisticated loan-type products, says one banker.

ôOne of the key trends we see with the China market is that it continues to open up and there is a dramatic expansion in terms of foreign trade and investment. BOC is particularly well positioned to benefit from that,ö he adds.

Another key selling point will be the management itself which, according to information provided to investors, has a average 21 years of industry experience. More than 40% of the mid-level and senior officials at the head office are also said to have overseas work experience.

Fund managers have noted the still somewhat unclear division of operations between BOC and its 66%-owned subsidiary BOC Hong Kong, which is already listed on Hong KongÆs main board. This is a key question that needs to be answered during the roadshow.

Another issue highlighted by syndicate research that has attracted some attention is its large unheeded foreign currency exposure, which amounted to about $40 billion at the end of 2005. Such a large position would leave the bank highly exposed to further appreciation of China's currency (versus the dollar), but sources say the bank has plans to reduce that by about half during 2006 and also has certain agreements in place with the government to help mitigate the risks.

However, for many investors the ultimate question with regard to the upcoming IPO will be how many shares they are likely to get.

ôBOC is such a large deal that you almost cannot afford not to buy it, but IÆm not spending too much time studying the details because amid the current hype it will be very difficult to get a decent allocation,ö says one fund manager.

For investors benchmarking themselves against any of the key benchmark indexes û MSCI, FTSE or the Hang Seng China Enterprises Index û they will have few choices but to buy. BOC is expected to join the indices after listing and with an allocation on the low side it will mean fund managers will have to chase the stock in a market which - if the demand for and performance of recent IPOs is anything to go by - is highly likely to be heading higher.

Since their respective listings in June and October last year, BoComm has gained 108% while CCB is up 54%.

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