China Merchants Bank sets out to prove that small is beautiful

The retail-focused bank sets H share price range to allow IPO discount versus peers and aims to raise up to $2.66 billion.
International investors will get their first real chance to buy into what has long been considered as ChinaÆs best run commercial bank when China Merchants Bank starts the roadshow for its H-share IPO today.

The privately-owned bank, which is the sixth largest Mainland lender in terms of assets, has been listed in the A share market since April 2002 but has been available to a limited number of foreign investors only through the QFII scheme.

The bank is looking to raise up to HK$20.69 billion ($2.66 billion) from the share offering after setting the price range at HK$7.30 to HK$8.55, according to sources familiar with the deal. The total size, which includes a greenshoe of up to 10%, is about 20% larger than the up to $2.2 billion initially expected by the market. This is thanks to the fact that CMBÆs A shares have gained 25% in the past two and a half months.

Since the beginning of August alone (when it became clear the IPO was imminent) the A share price has advanced 14% to FridayÆs close of Rmb8.34.

The H share price range straddles the current A share price, which equals about HK$7.92 after adjusting for the exchange rate and an Rmb0.18 per share dividend that only holders of the A share will be entitled to.

The range values the bank at 2.2 to 2.44 times its estimated fully diluted 2006 book value, or at 2.16 to 2.39 times if the greenshoe is exercised in full, according to the sources. This gives the bookrunners the option to price the sale at an IPO discount to other Hong Kong-listed mainland banks - that's despite the fact that most investors appear comfortable with the idea that CMB should trade at a premium because of its superior asset quality and risk management and its strong presence in the fast-growing retail segment of the market.

Its Hong Kong-listed peers trade at an average price to forward book value of 2.4 times, based on syndicate research. One syndicate analyst suggests CMB deserves a valuation premium of 15% to 25% over its state-owned peers.

China International Capital Corp, JPMorgan and UBS are joint bookrunners for the IPO which will comprise a base offering of 2.2 billion shares and a greenshoe of 220 million shares. All the shares will be new and together they will account for about 15.2% of the enlarged share capital.

The bank has received a waiver from the stock exchange that will allow it to earmark only 5% of the sale to retail investors, compared with the usual 10%, and the maximum clawback will also be capped at 20% of the total sale, leaving at least 80% for institutional investors.

A number of Hong Kong tycoons have expressed an interest in buying the shares, but unusually for a Hong Kong IPO these days none of them have been guaranteed a set allocation prior to the roadshow. Some of them are still likely to get shares through the institutional portion of the deal, but their investments wonÆt be disclosed in the prospectus and their lock-up arrangements (if any) are likely to be less strict.

While significantly smaller than its state-owned peers, CMB has seen strong growth since it was established in 1987 by a group of mainland corporates, including the China Merchants Group and COSCO, and has built a premium brand name within retail banking in particular. Between 2000 and 2005 the bankÆs total deposits and loans grew at a compound annual growth rate of 31% and 34% respectively, compared with a sector average of 20% deposit growth and 14% loan growth.

It has achieved that growth without sacrificing its credit quality and contrary to its state-owned peers, it has not received any financial injections from the government. As of the end of June this year, it had total assets of about $103 billion.

ôChina Merchants Bank is a leader within consumer banking which is the most profitable area and it doesnÆt have a legacy of being forced to lend money to state-owned enterprises. This means that even if China slows down it is not going to get hit by billions of dollars worth of NPLs,ö says one observer.

For the first half of 2006, China Merchants BankÆs non-performing loan ratio stood at 2.3% with a high coverage ratio of 123%. The formation of net new NPLs was low at only 6 basis points of average loans, syndicate research shows. The NPL ratio is expected to drop to 1.9% by 2008.

The preference for a high coverage ratio together with a high effective tax rate are seen as the key reasons for a below-average ROA compared with its peers in developing Asia. At the end of 2005, the bank reported ROA of 1.53%.

However, most potential investors are focusing on the growth opportunities within retail banking, where China Merchants has built a strong base of affluent urban customers. This has helped it become ChinaÆs leading credit card issuer with a 34% market share in terms of card issuance and 31% by card spending.

As big as that sounds, both the credit card market and consumer banking in general are still very underpenetrated areas of the banking sector with a lot of growth expected in the coming few years, syndicate analysts say. Despite its strong market share CMB still derives about 80% of its pre-tax profits from corporate banking and only 13% from personal banking. The bank also has a strong presence within retail mortgages, although its 4% share of the overall mortgage market makes this business stand out less than its credit card operations.

China Merchants Bank will face fierce competition from its Big Four peers which are keen to increase their presence in this market û CCB in particular has shown very aggressive growth both in the number of cards issued and the total spending since its IPO in October 2005 and is closing in on China Merchants BankÆs market share.

But given its first-mover advantage and base of wealthy depositors, China Merchants Bank should be able to capture a significant share of the growing pie, the analysts argue.

ôWe expect to see state-owned banks report very handsome-looking numbers for the volume of credit cards issued in the next two or three years,ö says one syndicate analyst, who projects CMBÆs market share will decline to 25%-30% by the end of 2008 from its estimate of 42% at the end of 2005.

ôHaving said that, we believe the enormous growth potential in ChinaÆs credit card market is more than enough to compensate CMB for potential market share lossàThe bank is will still be able to double its number of cards issued and operating income from the credit card operations from 2005 to 2008,ö the analyst adds.

The bank is expected to post 47% growth in net profit this year to Rmb5.5 billon followed by 36% growth in 2007 and 14%-27% in 2008, depending on which projections one looks at.

Aside from the question of whether CMB will be able to maintain its leading position in the retail market, most concerns expressed by investors relate to ChinaÆs banking sector as a whole rather than to CMB specifically. Among them are an economic slowdown and further interest rate hikes that could reduce margins.

The IPO price is expected to be fixed on September 15 and the trading debut is scheduled for September 22.
¬ Haymarket Media Limited. All rights reserved.
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