China Metal Recycling prices IPO at the top

The scrap metal recycling company raises $200 million to become the second-largest Hong Kong IPO year-to-date. Strong retail demand triggers a clawback that boosts the retail tranche to 30%.

China Metal Recycling (CMR), China's largest scrap metal recycling company in terms of revenue, has fixed the price on its initial public offering at the top of the range following strong demand from both institutional and retail investors, a source said yesterday.

Based on a price of HK$5.18 per share, the total deal size will be HK$1.55 billion ($200 million), making this the second largest IPO in Hong Kong this year after China Zhongwang's (admittedly much larger) $1.28 billion offering in early May.

According to the source, the retail tranche will be increased to 30% from the original 10% after the Hong Kong retail public subscribed to about 44 times the number of shares initial earmarked for them. On the one hand this could increase the demand from institutional investors when the stock starts trading on June 22, as they may wish to add to their holdings after their IPO allocations will have to be scaled back to accommodated the clawback to the retail tranche. On the other hand, there is a risk that more shares will flow back into the market on day one as retail investors attempt to secure a quick profit -- or cut their losses depending on which way the wind blows on the day. Hong Kong retail investors are known for flipping IPO shares on the first day to get enough cash to repay the margin loans they used when they bought the stock.

As the Hong Kong market has softened over the past few sessions, additional selling pressure on the first day of trading will clearly not be helpful. However, if Tuesday's debut by specialty chemicals producer Lumena Resources is anything to go by, there should be sufficient demand in the market to pick up the slack. While the two companies operate in different industries, they are both high-growth small-caps based in China, which suggests that they may have overlapping investor bases.

There was no immediate information about the institutional order amount for CMR, although sources said the deal was "extremely well covered" with more than 160 names in the book. Some of that demand was said to have been due to inflated orders, however, as investors got word after the first couple of days of bookbuilding that this was a going to be "a hot deal."For the same reason, there was virtually no price sensitivity in the order book, which meant it would have been hard to justify not fixing the price at the top.

The institutional buyers included small-cap and China-focused funds as well as a few "clean and green" specialists.

Lumena gained 19% on the first day of trading to close just 1 HK cent off its intraday high. It also saw heavy turnover with 557 million shares, equal to 96.5% of the IPO size, changing hands. Contrary to CMR, Lumena allocated only 10% of its total deal size to retail investors as demand was less buoyant. It also priced the deal in the bottom half of the range, even though there was said to have been sufficient orders to price at the mid-point. Real Gold Mining and Silver Base Group, which raised just over $130 million in their respective IPOs in February and early April, allocated 40% and 30% to retail investors after their offerings saw similar over-subscription ratios to CMR. Both stocks traded down on debut and it took Real Gold three months to move above the IPO price. Silver Base has still not managed to break above its IPO level.

However, CMR attracted a lot of attention and it is also coming to market on the back of a much more favourable sentiment for equities, even if the rally has flattened out over the past week-and-a-half. 

CMR sold 300 million new shares, or 30% of its enlarged share capital through the IPO, which was arranged by UBS. The deal includes a 15% overallotment option that may be exercised within 30 days if the strong demand continues in the secondary market. After being marketed in a range between HK$3.98 and HK$5.18, the price was fixed at HK$5.18, which translates into 12.5 times the company's 2009 earnings, which according to syndicate research is expected to end up around HK$415 million - an increase of about 41% from 2008. Looking ahead to 2010, the price-to-earnings ratio drops to 6.3 times.

While there is no direct listed comparable to CMR either in Hong Kong or China, a couple of investors said they thought the valuation was quite reasonable.

The source added that investors who put in orders also like the company because of its "clean and green" theme, the high-growth equity story and the fact that it is an early mover in a niche industry.

"It cheques all the right boxes and people are in the mood to play small-caps right now," remarked one observer, who noted that it was also helpful that the deal was not going head-to-head with any other Hong Kong IPO.

According to its listing document, CMR benefits not only from the growing interest in the "clean and green" theme, but also from the significant growth in the consumption of both steel and copper in China over the past few years.

The company buys scrap steel, scrap copper and other scrap metal and uses heavy machinery and manual labour to separate it into its various metal components. From that it produces scrap metal products of varying purity and sizes that it then sells on to manufacturers of that respective metal for further processing into new metal products.

It currently has three recycling facilities in China's Guangdong and Jiangsu provinces and in Hong Kong. It is also in the process of setting up a second facility in Jiangsu, as well as new facilities in the city of Tianjin and in the Zhejiang province, which are expected to be completed by the end of the third quarter this year and will almost double its annual production capacity to 3.1 million tonnes from 1.6 million at present. The company also plans to open a new recycling facility in Hubei province in central China in 2010, which will increase the capacity to 3.6 million tonnes.

CMR will use about 60% of the net IPO proceeds to pay off a high-coupon note was bought by UBS and two hedge fund managers - Spinnaker and ADM - in 2007 at a time when the company had trouble obtaining funding by other means as its asset-light business had no natural collateral to offer the lenders. The remaining 40% will be spent on inventories, production facilities and equipment at its new and existing facilities.

The strong demand for CMR and Lumena's solid trading should be helpful for the three Hong Kong IPOs that are currently in the market. Aside from sportswear retailer and manufacturer 361 Degrees and shampoo maker Bawang International, which FinanceAsia has written about earlier, coal trader China Qinfa Group is also currently marketing a smaller IPO of up to $80 million. In addition to purchases and sales of coal, the company provides a variety of services to its customers such as sourcing, filtering, storage, blending, shipping and transportation. The latter is focused on helping the industry overcome the bottleneck that is caused by the fact that China's coal resources are mainly located in the western and northern parts of the country, while most of the end-users are in the coastal areas.

Qinfa, which is scheduled to price its offering on June 24 and list on July 3, is offering 300 million new shares at a price between HK$2 and HK$2.52 per share. The price range values the company at 7.5 to 9.5 times its 2008 earnings.

China Everbright Capital is the sole bookrunner for that offering.

361 Degrees is aiming to raise up to $280 million with the help of Bank of America-Merrill Lynch, while Bawang has enlisted HSBC and Morgan Stanley to help it raise up to $215 million.

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