China Netcom fixes IPO price

Attractive valuation pays off with large order book.

Chinese fixed line operator China Netcom priced its Hong Kong and New York IPO just above the mid point of the range yesterday (November 10) raising HK$8.87 billion ($1.14 billion) from the deal pre greenshoe. Thanks to a recent uptick in the share price of China Telecom, the IPO valuation started to appear extremely attractive in the last few days of the bookbuilding process resulting in a very strong institutional order book of $16 billion.

The 1.046 billion share deal was priced at HK$8.48 versus a marketed range of HK$7.88 to HK$9. The ADR component of the deal was priced at $21.82 via lead managers CICC, Citigroup and Goldman Sachs.

Final pricing represented a 2005 P/E ratio of 7.3 to 7.6 times based on syndicate profit forecasts ranging from Rmb7.5 billion to Rmb8 billion ($920 million to $970 million). At the time of pricing, China Telecom was trading at HK$2.675, equating to a 2005 P/E ratio spanning 9.1 to 10.2 times depending on which bank's forecasts are used.

This means that China Netcom has priced at a 16.5% to 28.5% discount to China Telecom at the outer ends of the two ranges, or 22.5% in the middle. At the beginning of roadshows, fund managers said they believed Netcom should be valued at a 10% discount to Telecom.

A generous discount can be partially explained by the strong run up in China Telecom's share price over the past week. Since November 2 it has climbed 7.8%, although it is still down nearly 15% year-to-date.

It can also be attributed to the need for an IPO discount.

In terms of price to book, Netcom has come in at 1.1 times, just above the regulatory minimum. Bankers say it will run a dividend yield of 3.8% versus 2.78% for Telecom.

Non syndicate bankers believe the deal was successful because it was cheap. Nonetheless, most commend the lead managers for avoiding the pitfalls China Telecom fell into during its IPO in autumn 2002, when the whole deal had to be re-sized and priced.

As one says, "China Netcom is a good company, but the sector is not easy and the leads did well to get a sensible valuation and good dividend yield in place. Once they'd done this, they could hook accounts in at the bottom and build momentum to push pricing up."

This momentum was given a last minute push on the day of pricing by Chinese news reports, which suggest that China Unicom will be broken up, with its CDMA business going to Netcom and its GSM business to Telecom. Its fixed line businesses would be divided between the two.

If the reports prove to be correct, the government will have gone some way to clearing up a major uncertainty hanging over three listed operators. Investors have been waiting to see what the government decides to do with regard to mobile licenses for the two fixed lines operators, which are the only national incumbents in Asia that do not currently hold a mobile license.

Analysts have continually pointed out that until the uncertainty is cleared up neither Telecom nor Netcom will escape their low valuation range relative to their integrated Asian peers, which are currently averaging 12.5 times 2005 earnings.

However, even before these rumours became public, observers say the order book built well and had been covered since the first few days of roadshows.

Total institutional demand is said to have hit $16 billion, resulting in an oversubscription ratio around the same level. Retail demand came in at 28 times and resulted in an increased allocation from 10% to 30%.

The Japanese POWL (Public Offer Without Listing) attracted an order book of $2 billion and was allocated $75 million, or 6.6% of the entire deal. It was jointly led by Daiwa SMBC and Nomura.

Of the remaining 63% to 64% of the deal, about 45% went to institutions and the rest to corporate and high net worth accounts.

Observers report the participation of just over 500 investors and a lot of very inflated orders, resulting in about 50 requests for more than $100 million.

"The market has been very supportive of this deal," comments one specialist. "The US elections didn't cause any major disturbances and oil prices have eased off nicely. Even news about management re-shuffles at the three other operators didn't affect demand. A few years ago that kind of sudden and abrupt policy announcement would have given us all heart attacks."