China Mobile shows market agility

An unparalleled year for China''s privatization programme will be capped by yesterday''s record stock offering from its largest cellular company and the dual listing of its largest IP backbone, which began pre-marketing on Monday.

Fund managers eager to capture the upside generated by the country's economic re-structuring and privatization programme have ploughed $19.22 billion into the PRC's two largest telecommunications and oil companies since the beginning the year. All four offerings have shared a common thread linking the strategic investors anchoring every deal with the large index players who have similarly regarded each one as a must-buy.

China Mobile's ambitions to partially fund the acquisition of seven networks with a $6.6 billion share placement and $600 million convertible has upped the ante a few notches further, however. With similarly large offerings by European and US wireless companies falling prey to volatile markets and deteriorating investor sentiment, few were sure how securely it would be able to pin down demand.

Bankers at lead managers Goldman Sachs, Merrill Lynch and China International Capital Corp (CICC) believe that the successful completion of the transaction marks a turning point for the company. Says Merrill Lynch Asian syndicate head Kester Ng, "With the acquisition of the seven networks, China Mobile becomes the second largest wireless company in the world by subscriber number. From just making it into the top ten, this is where it crosses over to being truly global in standing."

Likewise, Goldman Sachs head of Asian equity capital markets, Mike Ryan comments, "China Mobile is now absolutely in the super league, one of only a handful or less of global wireless companies. We are extremely pleased that this deal has been such a success, especially given the turbulence of market conditions and the general negativity sentiment surrounding telecoms sector."

Ranking as the largest equity issue from non-Japan Asia, the 1.07 billion common stock offering was priced at HK$48 ($6.16) per share, representing a 4.5% discount to China Mobile's HK$50.25 close yesterday (Tuesday). A total of 400 orders were counted in the final book, which was variously said to have closed three times oversubscribed, just over two times oversubscribed, or 1.8 times oversubscribed.

Most observers consider the latter figure to be correct, with institutions said to have placed orders for about $5.1 billion and retail investors $2.4 billion. Geographically, bankers report that the US accounted for about 50% of demand, followed by Asia on 30% and Europe 20%.

Lead officials also say that new investors made up just over 50% in terms of ticket number, but just under 50% in terms of dollar demand. "As Asian-focused funds are already pretty fully weighted, the key to getting this deal done was to target the global telecoms specialists," says one banker. "Again, it reflects the fact that this company is no longer a China play, but has moved on to become a global play."

Indeed, bankers report that although many Asian-focused funds are moving out of Korea and Taiwan into Hong Kong and China, most are targeting defensive plays, particularly utility stocks.

And a second banker adds, "You would be really quite surprised by just how many funds have never invested in this company before and have virtually no understanding of China. A US fund manager with say $8 billion to invest in domestic telecom stocks is not paid to look elsewhere. Part of what has made them do so is Vodafone's investment in Mobile. The former is the world's largest wireless company and investors and analysts that track it have to look at China Mobile now as well."

In taking up $2.5 billion of the share placement, the British wireless company has acquired a 2.18% stake in China Mobile. The public float will remain fairly static around the 25% mark, however, since parent company China Mobile Communications Corp is receiving shares as consideration for approximately 75% of the $32.84 billion purchase price of the seven networks.

Alongside the three leads, Jardine Fleming and UBS Warburg are co-leads, with a further six co-managers in the international tranche and five in the Asian tranche. Fees total 1.8%.

Most syndicate bankers agree that the company has been realistic about what it could achieve. Although it was said to have been expecting a slim discount to spot, most outside observers long concluded that a figure outside the 2% to 3% discount range would be necessary. "There was definitely a psychological barrier at HK$50, but we were a little surprised that pricing wasn't pushed that little bit closer to HK$49," one states.

Coming the wrong side of HK$49 was largely attributed to the fact that retail investors constituted such a large component of the book. "Once you knock them out of the picture, that doesn't leave much room for the leads to manoeuvre," one banker argues. "Since there won't be much scaling back, the stock could be in for a bumpy ride."

Most also believe that hedge funds and prop desks played a key role, with the overhang of the offering and heavy shorting activity bringing the stock down about 15% since the deal was announced in early October.    

"There was a deal to be done," one syndicate banker concludes. "But with these conditions and such a large size, it was always going to be hard work."

Convertible attracts all-comers

Yet, for many observers, it is not so much the share placement which has grabbed attention, but the accompanying $600 million convertible bond, which drew unprecedented demand and is said to have closed with an order book topping the $17 billion mark.

At these levels, the deal closed nearly 25 times subscribed, although bankers say that the real figure is about 15 times once the froth is cleared away. Most also agree that the runaway success of the deal does not so much derive from generous pricing, but the combination of appealing terms and fortuitous market timing.

According to analysts, more funds were raised from the equity-linked market in Asia during the third quarter of this year than at any point in its history. Taking into account those deals exchangeable into non-Asian companies - Hutchison Whampoa/Vodafone and Jardine Matheson/Robert Fleming, total issuance comes to $5.2 billion. As one banker puts it, "Over the last six weeks, equity-linked issuance has accounted for 30% of all issuance, which is quite unprecedented."

Were it not for the fact that China Mobile does not want to carry dollar-denominated debt on a renminbi-driven balance sheet, the size of the convertible could easily have been increased to the benefit of a smaller share offering. With such an option precluded by the difficulties of hedging the currency, however, the company settled instead for a transaction that has set a new marker for Asia.

Pricing of the coupon was set last week at 2.25%, inside a 2.5% to 3% indicative range. The conversion premium, as expected, came at the top end of an 18% to 23% range over the placement price. Against a conversion price of HK$59.04, there is a conversion ratio of 132.0187. Incorporating a par redemption structure, the five-year deal also has hard no-call for two years, thereafter subject to a 120% trigger. This gives the transaction a bond floor of 76.3 and an equity option value of 33, equating to a theoretical value of 109.3. 

"This sets new records for Asia," one banker remarks. "There has never been a deal with a bond floor this low, or implied volatility this high. Investors normally demand bond floors in the mid 90 level to protect their downside risk and it's rare to see premiums above 20%. Even Hutchison Whampoa had a floor of 87 and implied volatility of 28%."

In terms of demand, an order book of 700 accounts was said to have been generated, of which about 30% to 40% comprise new entrants to Asia. "No Asian deal has ever achieved this level of global penetration and I've never seen an order book like it," one lead official notes. "The fact that the deal was registered in the US encouraged a lot of institutions there to participate and we also saw Swiss franc investors and retail investors for the first time. Any serious convertible account was represented."

What made the transaction so appealing was the combination of a strong and easily sellable credit, with a powerful growth story and stock that can be easily hedged. And despite its small size relative to demand, the deal is also still liquid by Asian standards and has novelty value, since it is the first time that China Mobile has ever tapped the convertible market.

In a first for the region, the deal also incorporates a change of control put option at par plus accrued interest should the company be de-listed, or the Chinese government sell down below 51%. Similiar to Hutchison Whampoa, there is also extraordinary dividend protection in the event of the company breaking its no dividend policy.

Proof of the deal's success is already being demonstrated by its trading record. For most of last week, the deal was trading up to 103 in the grey market, hitting a high of 105 yesterday after final terms were announced.

For analysts, the appeal of the company is clear. As Prudential-Bache analyst Andy Perkins puts it, "There is still upside to the stock and we have a target price of HK$70 on it. The top line growth story is attractive, with EBITDA margins increasing by the year. The cost controls put in place by the company have been impressive too. Thus, although average revenue per user is falling, costs are going down even faster."

From investors, there is a similar refrain. Says Adrian Fu of Investec Guinness Flight Asia, "We are very positive on the company and like the fact that it remains the market leader, but doesn't play the market share game. It always prices its tariffs at a premium to competitors and this means that shareholders will receive a bigger return.

"We believe the stock price has a lot of growth potential," he adds, "but we didn't participate in the offering as we already have a substantial weighting. But now that the overhang from the share placement has been removed, we think we've seen the bottom for its share price."

Jitong gets going

Right behind China Mobile, Jitong Communications is hoping to secure a dual listing in Hong Kong and New York, with pre-marketing begun at the start of the week. Dresdner Kleinwort Benson and Lehman Brothers are joint lead managers for a roughly $500 million transaction, with BNP Prime Peregrine senior co-lead.

As one of four internet backbones in China, Jitong operates the China Golden Bridge Information Network providing data communications, as well as supplying internet access, server hosting, roaming serves and domain name and IP address application. Internet phone services were first introduced in China last year and according to statistics released by the Ministry of Information Industry (MII), Jitong's main shareholder, the company has built a 12.3% market share, compared to 31.2% for Unicom and 54.4% share for China Telecom.


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