Even without the shoe, this will be the third largest IPO in Hong Kong this year after China Construction Railway Corp (CRCC) and rice cracker maker China Want Want, which raised $2.55 billion and $1.04 billion respectively in the first half of March. The third largest listing at the moment is casino operator SJM Holding, which raised $494 million last month in a deal that was partly taken up by the underwriter.
However, the deal size is quite a bit smaller than the $600 million to $700 million (pre-shoe) that was rumoured only a few weeks ago, and suggests that there were quite a few investors who were unwilling to pay more than 20 times this yearÆs earnings. Although, according to one source, the feedback from the pre-marketing of the A-share tranche would have made it possible to fix the A-share price above 20 times earnings, but supposedly the parties involved (including the Chinese regulator who needs to approve the price range) felt the broader market might not have been supportive of such a move given the continuing volatility and thin interest for most other IPOs in Hong Kong and China.
Some earlier reports had suggested that China International Capital Corp (CICC) and Macquarie, which are joint bookrunners for the H-share portion, were initially testing the market with a potential 2008 price-to-earnings valuation of 24-25 times.
At the current price range, which has been set at HK$2.49 to HK$2.76 per share, the Chinese train manufacturer is valued at 17.6 to 19.6 times this yearÆs earnings, which are projected to more than double from the Rmb613 million ($90 million) the company made in 2007, and at 13.2 to 14.7 times its estimated earnings for 2009, according to sources.
Adjusted for an exchange rate of 0.8765 HK dollars to the renminbi, the low end of the H-share price range is less than 1 renminbi above the top end of the A-share range, which has been set at Rmb2.10 to Rmb2.18. The two-day bookbuilding for the A-share portion also started yesterday and the final A-share price will be announced on Thursday, while bookbuilding for the H-share tranche is still ongoing.
The maximum size of the A-share tranche is Rmb6.54 billion ($957 million), meaning that the company is looking to raise up to $1.52 billion from the two tranches combined, or $1.6 billion with the H-share greenshoe. The A-share offering doesnÆt have a greenshoe.
The H-share price range pitches the company at a sizeable discount towards infrastructure firms CRCC and China Railway Group, which currently trade just above 30 times this yearÆs earnings. The two are viewed as the closest comparables because of their involvement with railway construction, while CSR is ChinaÆs largest manufacturer of railway rolling stock with a domestic market share of just over 50%. It also exports locomotives to more than 30 countries. Its product line spans everything that rolls on top of the rails, including engines, passenger carriages and freight wagons and it also gets part of its income from maintenance and servicing contracts, and leasing.
This means the three companies are impacted by the same macro economic issues and will all benefit from the Chinese government plans to invest on average more than Rmb100 billion ($15 billion) per year in various railway construction projects until 2020. One syndicate research report notes that with the development of 55 new rapid transit lines in some 14 cities, China will need a total of 6,000 rapid transit vehicles by 2010, which compares with a total production of 654 such vehicles in 2006.
This backdrop is expected to attract investors to the offering and has also helped China Railway Group and CRCC to hold above their IPO prices since their respective listings in December and March, despite the challenging market conditions. However, observers have noted rising raw material prices as a key risk to be aware of as contracts based on a fixed-price formula makes it difficult for CSR to pass on higher input costs. To alleviate the pressure on its margins, the company has in recent years put more focus on high margin products such as high-speed trains, multiple units and rapid transit vehicles. By the first quarter this year its gross margin had improved to 18.2% from 13.6% in 2005.
The valuation floor is set largely in line with Zhuzhou CSR Times Electric, which is a subsidiary of CSR that is already listed in Hong Kong. The company, which makes electrical systems, train power converters, auxiliary power supply equipment and control systems for ChinaÆs railway industry, is currently trading at about 18 times its 2008 earnings. Zhuzhou came to market in December 2006 at a price of HK$5.30 following an IPO that was arranged by Macquarie. The share price doubled quite quickly and then spent the next 12 months hovering between HK$12 and HK$14 before falling with the general market this year. Yesterday it closed at HK$6.82.
To further improve the chances of success, CICC and Macquarie have signed up three cornerstone investors who will each buy $30 million of the offering. Depending on where within the range the final price ends up, this means 15.9% to 17.6% of the deal is already covered. One of them û China Life Insurance û is an often featured name as a cornerstone in Hong Kong IPOs. The other two - GE Capital Equity Investors and Korea-based Mirae Asset Global Investment û are new to the role, and suggests that it may have been quite difficult to find investors who were willing to commit to the deal to the extent that theyÆd be locked up for a certain period of time in todayÆs volatile market.
Bankers have previously said that this has been the case and cornerstones havenÆt really featured in any significant size since the CRCC and Want Want IPOs. The three companies will be locked up for six months.
The H-share offer comprises 1.6 billion new shares (pre-shoe), which accounts for 13.8% of the company. As usual, 10% of the offering will be set aside for Hong Kong retail investors in a 3.5-day offering that will kick off on August 8. Standard clawback triggers apply and could trigger an increase of the retail tranche to up to 50% of the deal in case of strong demand.
The A-share tranche, which is arranged by CICC and Industrial Securities, is made up of 3 billion new shares, or just over 25% of the company. Of the total, 750 million shares, or 25%, will be sold to institutional investors, while the remaining 2.25 billion shares will be offered to retail investors.
The H-share offering will close on August 13 and the bookrunners will fix the price after the New York close on that same day. The H-share trading debut is scheduled for August 21. The A-shares will debut in Shanghai a few days earlier on August 15, as required by the Chinese regulators who want Chinese companies to list in the domestic markets first. The same staggered process was followed in the case of China Railway Group and CRCC, which also completed near simultaneous listings in Shanghai and Hong Kong.