China Power: IPO generates overcapacity

Sensible valuation and marketing strategy ensures strong take-up.

China Power International Development (CPI) generated an allocation headache for lead manager Merrill Lynch on Friday after all tranches of its HK$2.5 billion ($321 million) IPO closed multiple times oversubscribed. Not since Mengniu Milk's IPO in early June has a HKSE listing by a Chinese company generated such a strong response from investors.

This enabled pricing of the 990 million share deal to come towards the top end of a HK$2.10 to HK$2.60 range, with pricing fixed at HK$2.53 per share. The company and lead manager are said to have deliberately left some upside to allow institutions to build a secondary market position after being massively scaled back during primary syndication.

Because the retail order book closed 295 times oversubscribed, clawbacks were triggered taking the retail allocation up from 10% to 50% of the deal. On top of this two strategic investors ate up a further 17.3%, with Singapore government investment arm Temasek receiving a 9.5% allocation or $30 million in shares and Henderson group billionaire Lee Shau Kee, 7.8% or $25 million.

On top of this a POWL (Public Offering Without Listing) in Japan was allocated $12.5 million, or roughly 4% of the overall deal after generating demand of $400 million. This left institutions with just 29.7% of the deal on the back of an order book topping $4.7 billion - an oversubscription ratio of just under 50 times based on the final allocation.

Because of the huge retail take-up, specialists say that nearly half of the 320 institutional orders were blanked during the allocation process. "It was important to make sure a core group of long-term holders got a decent allocation," says one specialist. "But the rest will be able to build a secondary market position fairly rapidly if retail starts flipping paper when the deal opens to trade."

By geography about 50% of the institutional book went to Asia, 30% to the US and 20% to Asia.

One of the big losers was POWL lead manager Nomura, which must have been extremely disappointed to get scaled back from its customary 10% to 15% allocation.

"Some investment banks seem to use the POWL as a convenient insurance policy rather than a fixed distribution channel," notes one specialist. "It's like going on holiday, taking out some insurance and then asking the travel agent for some of the premium back when everyone gets home safe and sound again."

The deal's strong demand underline how much the markets have changed since the second and third quarters when one China deal after another got priced at the bottom of the price range. Fearing that hard landing fears might still be driving China sentiment during the fourth quarter, Merrill's locked in two strategic investors at the end of the summer to inject some initial momentum into the process.

However, while investors still remain selective, the underlying market tone has become more upbeat over the past month giving investors the confidence to pile into deals where they can see the issuer has taken a sensible attitude towards valuation.

In this instance, CPI has been priced at 11.9 times 2005 earnings based on a syndicate consensus forecast of Rmb680 million ($82.25 million). This places it at a roughly 9% discount to the 13 times trading level of comparables such as Huaneng Power International and Datang.

This might seem reasonably aggressive given that most investors would expect a 10% IPO discount and CPI has a much smaller market cap and smaller asset base than its peers. On listing the company will have a market cap of $975 million and freefloat of 33% (pre shoe).

HPI has a market cap of over $9 billion, while Datang sits at just over $4 billion. Both companies have much larger asset bases than CPI - MW15,275 attributable installed capacity (HPI), MW6,940 (Datang) and MW3,010 (CPI).

However, the company led by Madame Li Xiaolin, the daughter of former Chinese premier Li Peng, successfully argued for a small differential on the basis of CPI's growth potential. With MW22,200 of attributable installed capacity at the parent, the potential for asset injections is high.