CIMH issues $489 million equity/CB combination

The company's chairman sells a 5% stake as part of the well-received offering after the share price rises more than 10 times since the IPO in late-2005.
China Infrastructure Machinery Holdings was in the capital markets yesterday raising funds to pay for its aggressive growth plans through a combined equity and convertible bond deal. As part of the transaction, the companyÆs chairman Li San Yim also took the opportunity to cash in some of the profits he is sitting on after the stock has soared 1,040% in the 16 months since its initial public offering.

The total deal size amounted to $489 million, with the upsized CB accounting for $287 million and $202 million coming from the placement by the chairman of 104 million existing shares. However, the chairman will then subscribe to 52 million new shares, ensuring that half of this money also goes to the company, which is ChinaÆs second largest manufacturer of wheel-loaders.

There has been speculation over the past few weeks that Hong Kong-listed CIMH would hit the capital markets as earlier talk of a strategic alliance with an international player in the same sector has so far failed to materialise and money for its expansion into new products and markets has to come from somewhere.

The company told investors yesterday that the proceeds from the equity and CB sale would go towards capex û which analysts estimate may reach as much as Rmb1.5 billion ($195 million) over the next two years û as well as product development and research.

Given the obvious need for money, it is no surprise that several banks, including Cazenove Asia which arranged the HK$430 million IPO, have been approaching the company with fund raising ideas. However, Morgan Stanley got a foot in early by suggesting a CB element that would allow the fast growing company both to increase its leverage and to sell equity at future market prices, which resulted in the US investment bank being awarded sole books.

Combination equity/CB transactions are not very common in Hong Kong with the most recent one being a $361 million offering by athletic shoe maker Yue Yuen Industrial in October last year, which was arranged by Merrill Lynch. Before that there had been no such trade since the beginning of 2004.

In February this year, Goldman Sachs led a $473 million combined follow-on sale of shares and CBs for Chinese real estate developer Yanlord Land Group, which is listed in Singapore.

The equity portion of the deal, which accounted for about 10% the company, was offered to investors at a price between HK$14.90 and HK$15.50, representing a discount of 5% to 8.7% versus the HK$16.32 close before the Easter Holidays. The stock was suspended yesterday to allow the deal to be launched at around 10 am Hong Kong time, and according to sources it was already covered by the lunchtime break.

The order books were kept open until 4pm, however, to give London-based investors a chance to participate and this also allowed some of the price sensitivity to be removed. But with the share price up 19% over the previous five trading days, it proved difficult to push the price above the mid-point of the range, and it was eventually fixed at HK$15.15 for a 7.2% discount to the most recent close.

However, compared with the five-day average price of HK$15.19, the discount was no more than 0.26%.

Despite the sharp share price gains over the past few months û the stock has risen from less than HK$6 since early November û demand was strong with about 50 participating investors and a book that ended up ômultiple timesö covered. Asian and European investors accounted for the bulk of the order amount with less than 10% of the interest coming from US investors, the sources say.

The companyÆs strong fundamentals and a recently announced 165% rise in its 2006 net profit were obvious drivers, but the stock has also been quite tightly held since the IPO which has made it difficult for investors to buy shares in bulk.

The pre-deal freefloat is 40.5%, but many of the institutional shareholders have been holders of the stock for the long-term, leaving much less than that to actually trade in the market. One banker not working on the deal noted that this ownership situation has likely contributed to the upward squeeze in the share price and other sources said a reason why the company chose to do a combined equity and CB deal (rather than just a CB) was in fact to improve liquidity and broaden the shareholder base.

As a result of this transaction, the stake held by the chairman and his wife through their jointly owned company, China Longgong, will fall from 59.5% to 52.3%.

The CB attracted even more interest with over 125 investors participating, which may have been partly due to pent-up demand for the asset class as there have been only two publicly marketed convertibles in Asia since mid-February. Both of these were small at $93 million and $120 million respectively.

The oversubscription ratio was not disclosed here either, but investors said the allocation suggested the deal had been more than five times covered û not too surprising perhaps as the CB offers an opportunity to participate in any future equity upside, but at the same time provides downside protection in case most of the gains have already happened.

The company initially offered to sell $232 million worth of CBs, which was based on 90 million underlying shares. This was later increased to 110 million underlying shares, which was the maximum allowed as it left the combined deal size at 20% of the existing share capital. Having fixed the pricing at the most aggressive end of the offering ranges, this resulted in a total CB size of $287 million.

The bonds have a five-year maturity with a three-year put and will pay no coupon. They were sold at par. The yield was fixed at 3.875%, which marked the bottom of a range that stretched to 4.375%. The conversion premium, on the other hand, was set at 35% over the equity placement price after being offered at 30% to 35%.

With the reference price already at a discount to the latest close, the effective premium was actually only 32.5%. Investors were seemingly not worried about that being too steep as shown by the quite low bond floor at 88.5% to 90%, which suggests they were willing to pay up for the equity option. The implied volatility is, however, also quite high at just under 36%. The latter compares with a historic volatility of about 66%, but given the thin liquidity in the stock it is ôalmost meaninglessö to look at the historic volatility, one observer notes.

There is an issuer call after three years, subject to a 130% hurdle, to force conversion if the share price continues to perform as strongly has it has in the past.

The underlying assumptions included a credit spread of 275 basis points, with Morgan Stanley said to have offered asset swaps for about 25% to 30% of the deal to provide confidence in the credit. However, not all of that was taken up as many investors were happy to buy the CBs on an outright basis. The stock borrow cost was assumed at 4% and there is a full dividend pass-through to the CB investors.

CIMH, which supplies machinery primarily to the infrastructure, construction and mining industries, is a key beneficiary as the Chinese government continues to pump money into large infrastructure projects. However, analysts project this company will grow at a faster pace than the industry as a whole in the coming few years as it diversifies into new products. At present CIMH derives more than 90% of its revenues from wheel-loaders, but last year it also started making forklifts and in the first half of this year it will add excavators and agricultural machinery to its list of products.

It is also set to focus more on exports û where gross margins are higher - and will set up its own finance lease company, which together with the improved product mix should help to mitigate slightly higher prices for steel products and raw materials, analysts say.

All the nine analysts who cover the company, according to Bloomberg data, have a ôbuyö or ôoutperformö recommendation on the stock. Target prices average HK$15.85 with Morgan Stanley being the most aggressive with a 12-month target of HK$17.60.
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