Chaoda reaps harvest from market

In one of the biggest placements from the private sector in China, Chaoda raises HK$700 million from new shares.

In a deal that further underlines how hot the equity markets are, Chinese agricultural company, Chaoda Modern Agriculture yesterday issued new equity worth HK$700 million ($89.7 million). The deal was huge in the sense that it represented 32 days worth of the stock's normal trading activity.

The deal, which was sole lead managed by CITIC Capital, represented 13.6% of Chaoda's stock and was three times covered within an hour of launch, selling to 50 institutional accounts from Asia, Europe and the US.

Proceeds will be used by the company to consolidate its position as the leader in China's farming industry. In particular, the company is hoping to lease more farmland as well as build more greenhouses, irrigation facilities and city warehouses.

"In agricultural terms," says Chaoda's CFO, Gordon Wang, "China is like the US in the 1920s. The industry is highly fragmented with 230 million producers. We, however, benefit from economies of scale. Our smallest farm is 300 hectares which is a 1000 times as large as the plots of the average producer."

Wang says investors were interested in the stock because this is a "unique time" for Chinese agriculture - in part because of government initiatives to deal with the rural economy. He says it was merely a coincidence that the deal followed so quickly on from the hugely oversubscribed IPO for China Green.

Wang says that Chaoda is the biggest in the agricultural sector in China and the most diversified in terms of production base and distribution coverage. The company's stock has performed well recently, rising from HK$2 at the beginning of November to a recent high of HK$3.20.

Yesterday's deal was launched at HK$2.5 a share, a 5.7% discount to the previous close of HK$2.65. The private sector company has a freefloat of 43%, with 70% of the freefloat held by institutions and the biggest single fund manager investor being Value Partners.

The stock remains something of a puzzle nevertheless. In the past three years it has seen revenues and profits rise over 10 times (net income surging from HK$67 million to HK$725 million), and return on equity hit almost 28%. Adding to the mix the company makes a profit margin of around 50% - an enormous amount for its industry.

Yet all of these numbers only translate into a price earning ratio of a dismal 7.8 times. Wang acknowledges that the share price and the PE ratio suffered after the scandal at Euro-Asia when its entrepreneur-founder was imprisoned for fraud.

"It was the closest comparable to our company and we were impacted by association. Now we are trying to establish a good track record and gain trust," he concludes.

The company's business model - which Wang says involves economies of scale and industrialised farming and intense quality control - relies heavily on leasing land from lots of smallholders. It is a business model which is producing high margins but which some investors are still not comfortable with - hence the low PE.

"There are no good comparables for us in the US," he adds. "And many investors don't understand our business model." However, the fact that such a large placement for the company could be done so quickly may suggest that is slowly changing. Alternatively it may simply indicate that the frenzied passion for China equity stories shows no sign of abating.

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