China Railway on track for "dual" listing

The combined A- and H-share offering could total $5.5 billion, with the H-share portion accounting for 45% of the deal.
China Railway Group has set the price range for an initial public offering that is likely to become the blueprint for future ôdualö listings in Hong Kong and Shanghai. The offering appears to be a compromise between BeijingÆs desire to have the countryÆs top companies list in the domestic market first and a realisation that many of these companies want and need to gain access to the international investors that Hong Kong can offer.

As opposed to Industrial and Commercial Bank of China and China Citic Bank, which both listed simultaneously in Shanghai and Hong Kong, China RailwayÆs A-share offering will be running a few days ahead of the H-share sale and will list in Shanghai a few days before its Hong Kong debut (December 3 and 7, respectively). The key to making the transaction work, however, is the fact that the H-share offering will be priced before the A-shares start trading, meaning the IPO price wonÆt be affected in case there is a sharp rally in the A-shares on the first day û as is commonly the case.

This means that this really is a dual listing in everything but the name. This is further underlined by the fact that BOC International and UBS are acting as joint underwriters both for the A-share and the H-share offerings. They are joined by two other bookrunners on the H-share deal û ABN AMRO Rothschild and JPMorgan.

According to sources, the H-share portion of the deal, which will account for 45% of the total base offering, will be marketed within a range of HK$5.03 and HK$5.78 per share. This gives a deal size of up to HK$19.2 billion ($2.48 billion). The institutional roadshow will kick off today and is scheduled to close on November 29. The final price will be determined a day later.

Meanwhile, the price range for the A-share offering has been set at Rmb4 to Rmb4.80 for a deal size of Rmb22.44 billion ($3.03 billion). Translated into Hong Kong dollars, this equals a range of HK$4.20 to HK$5.03, which means the A-share deal is likely to come at a discount to the H-share offering û if both deals are priced at the bottom, the discount will be 16.5%. However, as the top end of the A-share range corresponds to the bottom of the H-share range, theoretically at least, the price could be the same for both issues.

The fact that the entire A-share price range is below the H-share range comes as no surprise as Mainland regulators have stipulated that the final H-share price cannot be below the final A-share price. If the two ranges had overlapped, the bookrunners could have found themselves in an awkward situation if the A-share deal was priced at the top, but the demand for the H-shares called for a pricing closer to the mid-point or the bottom. It is understandable that they would want to avoid this.

Combining the H and A share offerings into one will give a maximum combined deal size of $5.51 billion which could see China Railway squeeze in just ahead of China Citic Bank as this yearÆs largest Hong Kong IPO. Citic Bank raised $5.4 billion from the base offering of its dual listing in April this year. However, looking at the H share portions alone, Citic Bank was significantly larger at $3.7 billion, compared with China RailwayÆs $2.48 billion.

China Railway is the largest construction company in China and Asia and the third largest in the world with transport infrastructure and municipal works projects in more than 55 different countries to its name. Among the key selling arguments, however, are the prospects on its home turf following an ambitious railway expansion plan outlined by the Chinese government in its 11th five-year plan. The target is to invest Rmb3.8 trillion ($512 billion) on the construction of transport infrastructure between 2006 and 2010, of which Rmb1.25 trillion ($168 billion) will go towards railways. Investments in railways will increase by 257% versus the 10th five-year plan, while investments in metropolitan railway systems will increase by 150%.

China Railway, which derives about 88% of its revenues and just over 60% of its operating profit from infrastructure construction û the rest comes from engineering equipment and component manufacturing; survey, design and consulting; and real estate development û should be in an excellent position to benefit from this, sources say.

They note that the companyÆs new contract value grew from Rmb131.2 billion in 2004 to Rmb197.5 billion in 2006. In the first nine months of this year, the company secured new contracts worth Rmb157.5 billion and, as of September 30, its order backlog amounted to Rmb191.7 billion. Aside from railways and subways its infrastructure business also include the construction of highways, bridges, tunnels, hydroelectricity projects, ports, airports and municipal works.

One syndicate research report suggests that China Railways will see steady revenue growth of 19% in 2007, 24% in 2008 and 24.5% in 2009. This should help support earnings growth of 20% this year, 57% in 2008 and 42% in 2009, representing a compound annual growth rate of 49%, the report says.

In 2006, the company posted a net profit of Rmb2.05 billion on revenues of Rmb153.6 billion. According to the company, its bottom line expanded 33% to Rmb643 million in the first half of this year.

While there are a lot of international infrastructure construction companies out there to compare the listing candidate to, most investors seem to be regarding China Communication Constructions Corp (CCCC) as a key benchmark, given that it operates in many of the same markets. CCCCÆs main focus is on ports design and construction, but it is also active within highway construction and municipal works projects and the overall business model of the two companies is quite similar. CCCC currently trades at a 2008 price-to-earnings multiple of 37.8 times, after rallying 380% since its own IPO in December 2006.

Not surprisingly, China Railway is being offered at a significant discount to that, which some observers say is likely to be needed given the large size of the deal and the current volatile market environment. So far, however, the angst over the secondary market doesnÆt appear to have spread to the primary market, and China Railway isnÆt expected to have any trouble finding sufficient demand for the deal.

Based on the consensus forecasts from the joint global coordinators for the H-share offering (BOCI, JPMorgan and UBS), China Railway is being pitched at a 2008 P/E ratio of 23.2 to 26.6 times. Including the 15% greenshoe, the valuations will increase slightly to 23.8 to 27.2 times, sources say.

The H-share portion of the deal consists of 3.326 billion shares, or 16% of the enlarged company, plus the 15% greenshoe, which could boost the H-share portion of the deal to $2.85 billion and the total deal size to $5.88 billion. There is no greenshoe on the A-share offering.

The A-share sale amounts to 4.675 billion shares. Post the transaction, but before the exercise of the greenshoe, the A-share holders will own 22.5% of the company and the H-share holders (including the National Social Security Fund) will own 17.6%. The remaining 59.9% will remain in the hands of its parent, China Railway Engineering Corp.
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