Chinese firms seek a combined $757 million

Shandong Chenming Paper and Chongqing Machinery both kicked off their institutional roadshows yesterday with the aim of raising $538 million and $219 million, respectively.
Shandong Chenming Paper Holdings, one of ChinaÆs largest paper producers, started bookbuilding yesterday for an initial public offering of H-shares that will raise between HK$3.2 billion and HK$4.2 billion ($410 million-$538 million), sources close to the deal have confirmed. The company is already listed in China's A- and B-share markets and, if the Hong Kong IPO is successful, it will be the first mainland company to have three categories of listed shares. This is of some consequence since the Chinese regulators have stipulated that the H-share price must be set in between the A- and B-share price.

The company is selling 17.25% of its total share capital and has set a price range between HK$9.00 and HK$11.80, which values it at 9.6 to 12.6 times its expected 2008 earnings. There is a greenshoe of 15%, which could bring the H-share float to 19.34% and the total proceeds to $619 million. The company will issue 355.7 million new H-shares, of which 90% will go to institutional investors and the remaining 10% to retail investors.

In terms of attracting investors' attention, the paper manufacturer will be going head-to-head with Chongqing Machinery, which also started bookbuilding yesterday. The company is one of western ChinaÆs largest industrial conglomerates in terms of revenue, and is seeking to raise between HK$1.31 billion and HK$1.72 billion ($168 million-$219 million). The price range has been set at HK$1.30 to HK$1.70 per share, valuing the listing candidate at nine to 12 times its projected 2008 earnings. This translates into a discount of up to 44% versus its most obvious comparable, Shanghai Electric, which is trading at a 2008 price-to-earnings ratio of 16.1 times.

Shandong Chenming is located in the northeastern province of Shandong and has no such obvious comparables, although investors tend to use Nine Dragons Paper and Lee & Man Paper as a reference, given that they too are listed in Hong Kong. However, analysts argue that this isnÆt comparing like with like as Nine Dragons and Lee & Man manufacture paper for use in packaging materials, while Shandong Chenming produces a diversified portfolio of products, including writing paper, art paper, newsprint and paperboard. According to analysts, the production of packaging paper requires different inputs than the production of paper used for writing and print and the two categories also sell to different markets.

ôFor writing paper the competition is far higher [than for packaging paper]. There are quite a number of players at this end of the market,ö says one analyst. Along with a tougher market, continues the analyst, the applications for products like writing paper are less diverse and the margins are lower. Despite this, Shandong Chenming is expected, according to one syndicate research report, to see its net profit increase at a compound annual growth rate of 44.3% in the period between 2007 and 2009.

The listing candidate, which is brought to market by Guotai Junan and Macquarie, is ChinaÆs largest paper producer in terms of revenue and the fourth largest in terms of production volume. Its annual production of 3.17 million tonnes also ranks it as the 25th largest paper manufacturer in the world.

When it comes to raw materials, Shandong Chenming faces greater pressure than companies like Nine Dragons as paper for packaging consists of very little pulp (the vast majority of the raw material input is recovered paper which is cheaper), while products like writing paper and art paper consist mostly of pulp. The demand for pulp, however, also presents opportunities for the Chinese paper producers.

ôThe bigger Chinese paper makers are all expanding upstream (because) pulp production is now more profitable than paper production,ö says an analyst. Shandong Chenming is already highly vertically integrated and 70% self-sufficient when it comes to its pulp needs, but the capital raised from the IPO will be used to develop its upstream capabilities even further through the construction of a 700,000 tonne pulping factory. The factory will be supported by 3 million mu (494,100 acres) of forestry land that is to be acquired by the company.

Nine Dragons and Lee & Man have been under pressure this year, and saw a huge drop in their share prices in March after Nine DragonsÆ six-month results came in below expectations and triggered concerns about margins and earnings prospects for the sector as a whole. After hitting a 12-month low of HK$5.85 a share on April 1, Nine Dragons has recovered to HK$8.00 (yesterdayÆs close), but it is still down 59% year-to-date. Lee & ManÆs 12-month low of HK$11.88 a share occurred on March 20 and while it has gained 26% to HK$14.98 since then, the stock is off 56% since the beginning of the year. As of yesterday, Nine Dragons traded at a fiscal 2008 (to end June) P/E multiple of 12.4 and a fiscal 2009 multiple of 9.4, while Lee & Man was quoted at a fiscal 2009 (to end March) multiple of 8.1.

Analysts are not in agreement over what has caused the losses. ôThe paper fever is already over. People thought that it was the best China consumption play, but a lot of people didnÆt realise that paper packing is a cyclical industry,ö one analyst argues.

Another analyst still ranks Nine Dragons as one of the bankÆs ôtop picksö based on the fact that there is an undersupply of packaging paper in China right now and the majority of its products are for domestic consumption. The analyst blames the March sell-off on the fact that paper manufacturers fell into a category of companies that had high P/E ratios û and therefore were more prone to profit taking when the market came under pressure û rather than on any fundamental problems with the companies in question.

One syndicate research report notes that the sell-off has eroded valuations in the sector to the extent that as of mid-April the Hong Kong-listed paper producers were quoted at an average 2008 P/E ratio of only 12 times and a 2009 P/E of 8.5 times û below the valuation of the Hang Seng Index at 15.5 times for 2008 and 13.7 times for 2009.

ôConsidering that the sector is still expected to grow at a CAGR of 30% in 2007-2009, based on market consensus, and the important single fact that paper product prices have been rising continuously to compensate for the rising raw material costs, we believe that the paper sector in Hong Kong is now undervalued, and it can be argued that the sectorÆs valuation should be above the Hang Seng Index,ö says the report.

Shandong ChenmingÆs A-shares have held up relatively well and are currently quoted at Rmb15.68 after falling only 2.9% this year, while the B-shares (which are much less liquid) closed at HK$8.46 yesterday and are up 1.8% year-to-date after a sharp rebound from March lows. The current B-share price is only 6% below the bottom of the indicated IPO range.

The deal is expected to be priced around June 10 and the trading debut planned for June 18.

Chongqing Machinery will have a more contracted roadshow and is planning to price its offering on June 6. The trading debut is set for June 13. Credit Suisse is the sole bookrunner for the IPO, which will see the company sell about 27% of its share capital in the form of 1.004 billion new shares.

The company has recorded a healthy growth in revenue û in 2007 its turnover was HK$5.4 billion ($692.3 million), representing a year-on-year increase of 28%. However, it is dependent on steel and copper and, if input prices continue to rise, they could cut into margins.

The company has four major product lines: components for commercial vehicles; equipment for power generation; computer numerical control tools; and general machinery. The new capital will be used to expand its range of products.

Chongqing MachineryÆs production facilities are located near to the epicentre of the recent Sichuan earthquake but were left unharmed, allowing the company to continue to profit from ChinaÆs ôGo-Westö policy. This government initiative is designed to address the imbalance in economic development between coastal China and the areas deeper in land, with a particular focus on western China. The area has benefited from a flood of infrastructure projects, and companies that are interested in investing there are lured with favourable policies. As a state-owned company located in the Chongqing municipality of Sichuan province, Chongqing Machinery is thought to be well situated to fully benefit from this policy.
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