Chinese forestry company raises $166 million

China Grand Forestry Resources prices its follow-on at an 11.4% discount, suggesting investors need some convincing to add to their exposure in the sector.
Hong Kong-listed timber producer China Grand Forestry Resources (CGF) yesterday raised HK$1.29 billion ($166 million) from a placement of new shares that will help fund its highly aggressive acquisition plans.

Like the block in property developer Greentown China Holdings last week, this Morgan Stanley-led follow-on was sold at a substantial discount to the most recent market price. But in light of the current unpredictable nature of the secondary market, and the fact that CGF is a volatile stock anyway, this was hardly surprising. The companyÆs share price has also rallied 215% since the beginning of May supported with a strong set of earnings. These gains include a sharp correction in the first two weeks of August. Since then, the stock has staged another impressive run, climbing by 55% and regaining most of its losses.

ôNo block trade will be a slam dunk in the current environment. You have to work hard to get them done,ö notes one observer.

The 539.56 million shares were offered at a price between HK$2.40 to HK$2.60, which translated into a discount of 4.1% to 11.4% versus FridayÆs closing price of HK$2.71. After about five hours of bookbuilding, the price was fixed at the bottom of the range for the maximum discount. The placement was launched at about 11am Hong Kong time after the stock was suspended, and early in the day most of the orders were said to have been at strike. However, towards the end of the bookbuild, when the chunkier orders started to come in, the deal became more price sensitive.

According to a source close to the transaction, the order book was between one and two times covered and attracted more than 40 investors. These included existing shareholders who wanted to top up their holdings and obviously wanted to do so at as low a price as possible. Most hedge funds still preferred to stay away, but one source noted that they were at least more numerous than in some of the other deals that have taken place during, or in the wake of, the correction triggered by the US subprime crisis.

The interest was also heavily skewed towards Asia with less than 10% of the order amount coming from Europe. In terms of the number of orders, Europe accounted for about 20%, however, which suggests investors there are participating but in smaller sizes than their Asian counterparts.

The deal, which equals 10.7% of the outstanding share capital, was launched on the back of a strong share price performance on Friday, both by CGF itself which gained 5% to HK$2.71, and by the Hong Kong and US markets as a whole. However, the local market came under pressure shortly after opening yesterday amid another rumour that cash from the pilot scheme that will allow Chinese nationals to invest in Hong Kong stocks might not be as free-flowing as earlier anticipated û and what initially looked like a good window of opportunity quickly turned into another difficult market day.

The HSI eventually finished just 0.3% blow FridayÆs record close after a strong finish to the day, which obviously helped attract interest to the placement. The groundwork for this transaction was likely laid in late July, however, when Morgan Stanley took CGF on a non-deal roadshow to meet investors. Before that exercise the stock would likely have been off the radar screen for many international investors seeing as among the international investment banks only Deutsche Bank and HSBC have research coverage on the company.

ChinaÆs forestry sector is becoming better known, however, and the announcement of a 10-point plan by the government to support the industry last month, including rebates and tax breaks, further highlighted the potential upside.

CGF specifically has also attracted interest on the back of its aggressive acquisition of new forestry land which has seen it expand its existing concession areas by 140% in the past three months alone, according to Deutsche Bank. The companyÆs target is to boost its total forestry land holdings to 10 million Mu (15 Mu = 1 hectare) in the next two years from 2.4 million Mu at present and analysts believe this ought to be feasible as CGF has already signed preliminary agreements to acquire another 10.6 million Mu.

In a recent conference call arranged by HSBC, the CGF management told investors that its target us to sell 500,000 cubic metres of timber in fiscal 2008, which end in March next year. It also noted that timber prices increased by 10%-15% in the January-July period and said it expects this trend to hold up in the second half of the year.

CGFÆs aggressive acquisition plans are not without execution risk, however, and the acquisition cost per Mu has also been rising recently as the competition for land is increasing. But both Deutsche and HSBC are still positive on the stock with target prices of HK$3.51 and HK$3.30, respectively, implying a potential upside from current levels of between 22% and 30%.
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