Chinese firms believe tough market can be beat

China South Locomotive prepares for a near simultaneous listing in Shanghai and Hong Kong by pre-marketing the $600 million H-share portion of the deal.
So far, the IPO market in 2008 has been all about finding and taking advantage of the few brief windows when equity investors have been receptive to new issues. For quite a few issuers, getting the timing wrong has meant pulling the deal just before pricing, or going ahead and watching the share price slide in the secondary market.

And the situation is showing few signs of improving with equity markets in both the US and Asia still highly volatile û with a negative bias û and extremely news-driven. Also, the traditional fund manager holiday month of August û this year further emphasised by the Beijing Olympics û is just around the corner. Surprisingly though, several Chinese companies have decided that right now is the right time for them to come to market.

At least two companies are aiming for a listing in the US, where bankers feel investors are still receptive to Asian issuers in the ôrightö sector as they look for growth stories away from the sluggish US market. So far this year, two Chinese companies have completed an IPO in the US, and while the ride has been a volatile one, both are currently trading above issue price, suggesting investors may not be too wary of having a go at another Chinese newcomer.

ChinaÆs largest maker of railway engines and carriages appears to be in for a greater challenge as it aims for a near simultaneous listing in Shanghai and Hong Kong at a time when the Shanghai Composite index has lost 45% since the beginning of the year. By comparison, the 20.8% drop in the Hang Seng Index is looking relatively benign.

The company, China South Locomotive & Rolling Stock, started pre-marketing for the Hong Kong-bound H-share portion of the deal yesterday and is planning to kick-off the institutional roadshow on July 25. It is expected to follow suit with the larger A-share tranche shortly as the approval by the mainland regulator stipulates that the A-shares need to start trading before the H-shares, following the same pattern as China Railway Group and China Railway Construction Corp (CRCC) before it.

According to sources, the company is looking to raise between $600 million and $700 million from the H-share portion alone and another $1.1 billion to $1.25 billion from the A-share portion. The Hong Kong offer will comprise 1.6 billion new shares and will account for about 14% of the company before the greenshoe, which could increase the deal by another 15%. One source says the A-share tranche will account for about 25% of the issued share capital. In an earlier filing with the Shanghai stock exchange, China South Locomotive said it would sell up to 3 billion A-shares, accounting for up to 30% of its total share capital.

The combined size has come down compared with earlier estimates as valuations in the broader market have deteriorated, but even at the current size it will be chunky in comparison to what else has been done this year. The H-share portion will be the third largest Hong Kong IPO this year after CRCC and rice cracker producer Want Want China Holdings, which raised $2.55 billion and $1.04 billion respectively in the first half of March.

To ensure there will be sufficient interest, joint bookrunners China International Capital Corp (CICC) and Macquarie Group are planning to lock up a few cornerstone investors over the next couple of weeks. While there are no firm agreements yet, sources say there are a few parties interested in supporting the deal as cornerstones û a feature that has barely been used since the CRCC and Want Want IPOs as investors have been reluctant to commit to a lockup in a falling market.

What makes the deal interesting is that the company is exposed to the same macro issues, including ChinaÆs commitment to expand its railway infrastructure, as China Railway Group and CRCC, which have held up relatively well since their respective listings despite the troublesome markets. While those two build the actual railway lines (among other things), China South Locomotive is responsible for everything that rolls on top of the rails, including engines, passenger carriages and freight wagons. Part of its income also comes from maintenance and servicing contracts.

China Railway has tumbled 47% from its high of HK$11.94 in January, but is still 9.3% above its December IPO price of HK$5.78. Similarly, CRCC has lost 16% from its HK$14 high, but as of yesterdayÆs close was still up 9.9% versus the HK$10.70 IPO price.

According to information included in CRCCÆs listing document, the Chinese government plans to invest on average more than Rmb100 billion ($15 billion) per year in various railway construction projects until 2020. In the five years to 2010 it aims to add 17,000km of new railway lines, including 7,000km of passenger railway lines to reach a total rail network length of more than 90,000km.

ôIf there is any sector that can survive the current market environment it is probably infrastructure,ö notes one source. ôNot only is it a growth sector, but it is also defensive since it is not exposed to either a US economic slowdown or domestic consumption.ö

As has been the case for most of this year though, the single most important factor for whether investors are willing to buy or not is valuation and the bookrunners will spend the next couple of weeks trying to determine where the price sensitivity lies before setting a price range. What is clear already is that the H-share investors will have to pay more than their counterparties in China as the mainland regulators have stated that the H-share tranche must be priced above the A-share tranche. For the deals that have been marketed almost simultaneously in both markets this has not been an issue in the past.

The H-share tranche is expected to close and price just before the Olympics, which kicks off on August 8.

Meanwhile in the US, China Distance Education Holdings (CDEL) is getting ready to launch an IPO of about $75 million to $100 million in the next couple of days, while China Mass Media International Advertising Corp filed for an IPO of up to $150 million on Friday.

CDEL is a provider of online education and test preparation courses for professionals, which means its business is almost complimentary to that of ATA û a provider of online exams and one of the two Chinese companies that have completed an IPO in the US this year. ATA raised a modest $46.3 million, but has performed well since its listing in January and is currently trading 33% above its IPO price of $9.50. A second Chinese education provider, New Oriental Education and Technology Group, which focuses on teaching English to Chinese professionals, has also been well supported after a sizeable drop in January. After hitting that bottom of $51, it has risen 25% to $64.56, although it is still off 21% since the beginning of the year.

Citi and Merrill Lynch are joint bookrunners for CDELÆs offering and Merrill is also the sole bookrunner for China Mass Media. The latter is an advertising agent for ChinaÆs CCTV and a producer of public service announcements. Given the proximity in time, it is bound to be compared with Sino Media, which also sells advertising space on CCTV and listed in Hong Kong on July 8. SinoMedia closed 1 HK cent below its HK$2.63 IPO price on its first day of trading and has continued to hover around those levels since then. Yesterday it finished at HK$2.61.
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