'China's GE' looks to brave poor market sentiment

Shanghai Electric Group will need to tell a convincing story ahead of its approx. $700 million H-share IPO in Hong Kong.

With market sentiment turning bearish in the past week on the back of interest rate risk in the US, as well as some fears of a China hard landing, the manufacturing conglomerate's timing might appear less than ideal.

Nevertheless, the company plans to price on April 6 ahead of the flotation of the equivalent of 25% of its enlarged share capital, or 29% post Greenshoe. The number of shares will amount to 2.97 billion shares pre-Greenshoe. Primary shares will represent 9.1% of the total.

CSFB is sole book runner, with Deutsche Bank, Daiwa Bank and Macquarie Bank acting as co-leads. Daiwa will manage the POWL (Public Offer Without Listing) in Japan for an as-yet unspecified amount.

The unit about to list is the holding company, owned by large state-owned enterprises and the Shanghai city government. The future listco contains four major divisions. These four major divisions contain some 20 subsidiaries, of which three (Shanghai Diesel Engine, Shanghai Transmission and Distribution and Shanghai Mechanical and Electrical) are listed on the mainland A and B share markets, to which foreign investors do not have access. Shanghai Electric has different levels of ownership in these listed subsidiaries, but together the stakes add up to around $750 million, meaning they will represent approximately 25% of the company's after its listing.

The A-share market has been through a difficult time, but specialists say that given the absence of research in the A share and B market, the performance of the domestically-listed subsidiaries will not be relevant to international investors, who will be analyzing Shanghai Electric on individual price earnings multiples for each division, or the average thereof.

The company's biggest division makes power equipment such as boilers, turbines and electric motors, amounting to almost 50% of sales. ,

The next-largest division, amounting to 35% of sales, makes electro-mechanical items such as elevators and air-conditioning units.

The next-largest division after that, amounting to about 15% of sales, makes transportation equipment such as rolling stock and locomotives.

Finally, a much smaller division, amounting to around 2% of sales but growing fast, makes environmental protection equipment.

The power equipment division is the driving force behind EBITDA growth (earnings before interest, tax, depreciation, and amortization), although the company is said to have a top five market share in all of its divisions.

Specialists have picked out two comparable companies for evaluation purposes: Harbin Power and Dongfang Power. Both are under $500 million in market cap, and will therefore be dwarfed by Shanghai Electric's market cap of $2.5 billion to $3 billion. These two companies and Shanghai Electric split the power equipment market evenly between them.

Harbin Power and Dongfang Power trade at P/E multiples of 13 times, and 8 times respectively. Further afield, GE, ABB, Alstom, Siemens and Mitsubishi Heavy trade at and average of around 20 times. The final set of comparables is Hong Kong's own H-shares, which trade around 14-15 times. Specialists say that Shanghai Electric is aiming to price at a premium to Harbin and Dongfang thanks to its diversified business model, and is being pitched at 14-15 times 2005 earnings.

At the end of 2004, the company recorded turnover of Rmb 25 billion ($3 billion), following 40% compounded annual growth since 2002. EBITDA, with margins of 11% (compared to Harbin's 2% and Dongfang's 5%) has grown at the same rate between 2002 and 2004. Net income and turnover is expected to grow in low-to-mid double digits for the coming year. Specialists warn that steel prices, the company's principal raw material, could put pressure on those margins if they rise further.

The business model of Shanghai Electric involves the early booking of long-term projects, and specialists say the order book is already full for the next year and a half, giving investors some earnings transparency.

The long-term projects slow down cash collection however, and this is one reason the company is going to the market, despite a debt to equity ratio of under 5%, compared to Harbin Power's 40% and Dongfang Power's 8%. The company also has a strong net cash position.

However, say specialists, the company wished to make its presence known to capital providers in Hong Kong to fund longer-term growth, as well as use the listing as an opportunity to tweak the company's corporate governance. However, investors say that given the absence of any clear projects on which to spend the IPO proceeds, the company will have to prove it has sufficient discipline not to overpay for acquisition targets or other investment.

The company also has joint ventures with all of its leading global competitors, involving some beneficial technology transfer. However, specialists point out that under World Trade Organization liberalization guide lines, these joint ventures could eventually be dissolved and the foreign partners set up their own wholly-owned companies.

Bankers acknowledge that the company's appeal as the 'classic China manufacturing story' operating in China's richest coastal provinces could be a double edged sword if macro growth weakens this year.

However, the very dearth of major China IPOs this year could end up helping the stock, comments one banker.

Share our publication on social media
Share our publication on social media