CNOOC to play it safe with IPO

In uncertain global equity markets, China National Offshore Oil Corporation (CNOOC) is to adopt a cautious stance with its $1.2 billion to $1.5 billion Hong Kong and New York Stock Exchange flotation.

In particular, one of the company's key selling points - the revenue-sharing rights for which it receives 51% of any profitable offshore discoveries made by foreign partners - have been accorded no monetary worth in the $7 billion to $8.5 billion Net Asset Value (NAV) attached to the company.

As one market observer explains: "It's been decided to make this the icing on top of the cake instead. The revenue-sharing rights are a very important part of what makes the company so successful, but they're also a very intangible option since it's almost impossible to extract value from yet-to-be-realized potential. It will be a sweetener for investors, whereas the first time CNOOC tried to list, it formed a significant part of the valuation."

The second major strategic decision by lead managers Credit Suisse First Boston, Merrill Lynch and Bank of China International, has been to pitch CNOOC midway between Chinese and global comparables. No-one would disagree that the company should be priced at a premium to Petrochina and Sinopec, both of which are essentially restructuring plays on the Chinese economy. The real disagreement centres on where the company should be ranked against global comparables, which trade at much higher EV/EBITDA multiples than the listed Chinese oil companies.

While, for example, Petrochina and Sinopec both currently trade at around 3.5 times 2001 earnings, Asian comparables such as Thailand's PTT&P are at about 5.5 times and fast growing E&P (exploration and production) companies such as Australia's Woodside Petroleum at 6.5 times.  

When the company was first readied for market via Salomon Smith Barney in October 1999, it was aggressively pitched at levels which its extremely strong fundamentals were felt to deserve on a standalone basis. This time round, however, CNOOC appears to be heading in the opposite direction, and at current valuations will leave a lot of upside on the table for investors.

Partly, this is said to be a reflection of the company's unhappy history in the international equity markets and its consequent determination to make sure that it gets things right now. Partly, it is also a reflection of the fragile state of the primary markets, where there has been little new paper this year and investors remain content to sit on their hands until they see what happens to the US economy.

As one industry expert says: "This is a deal which needs to be priced well. It's obviously not the best market for equity at the moment, but it's still a relatively good market for energy."  

Indeed, OPEC is expected to announce at its Vienna meeting today (Thursday) that it will cut production in an attempt to stem a decline in oil prices. Most analysts are forecasting an average price per barrel this year of between $22 to $25, compared to $30 at present.

And as one London-based global analyst puts it: "Prices will remain high on a historical basis, but we are in a declining oil price environment now and investors will, therefore, favour companies with high growth prospects to compensate." 

High growth

CNOOC is described as the ultimate pure oil play and also enjoys some of the highest growth rates in the industry. Comments one analyst: "It's the largest pure oil E&P company and the second largest overall E&P company in terms of proven reserves. In terms of production, however, it currently ranks eighth, which goes to show just how much potential it has."

With 1.8 billion barrels of crude oil in reserves as of the end of last September, the company has seen the figure jump 15% to 20% per annum over the last five years and forecasts that it will maintain a similar level over the coming three to five years.

"On a growth adjusted basis, CNOOC is fairly valued at the moment compared to its peers, but moving out to 2003 a big discount starts to emerge," the analyst continues. "When you also factor the lack of valuation for the revenue-sharing rights into the equation, then it starts to look very, very attractive."

Strong ratios

On virtually any global ratio, CNOOC stands up to the best. In terms of return-on-capital-employed (ROCE), the company commands a 21% level on a normalized crude oil basis in line with the super majors. Partly, this is attributable to the fact that as a relatively new company - established in 1984 - and has correspondingly young oil fields. By contrast, Petrochina and Sinopec, both of which still have some way to go in their restructuring efforts, average ROCEs of respectively 10% and 9%.

In terms of lifting cost - the ultimate oil industry efficiency measure - the company straddles the industry average, achieving a production cost of $3.50 per barrel. However, as one expert remarks: "Where it outperforms the sector is in the cash flow it can earn on top of this. At $7 per barrel, the company benefits massively from a low tax regime."

Why 2001 may provide a better launch pad than 1999

In October 1999, all these factors, in tandem with the company's perceived management and communications skills, prompted a high valuation which investors subsequently proved unwilling to accept. At the time, lead manager Salomon Smith Barney received widespread criticism for misreading market sentiment. In retrospect, it has sometimes been grudgingly acknowledged that the Chinese government itself failed to show the flexibility it needed when it became clear that global investors were not prepared to accept the story it was trying to sell them.

Where the first time round the government did not want to involve strategic investors, it has since learnt that their participation can give a deal its first crucial lift. Consequently, CNOOC has sold $460 million in equity to a group of corporate investors prior to the IPO and agreed to let Shell purchase a minimum of $200 million from the forthcoming offering.

Company experts also report that a number of other oil companies are in discussions to purchase strategic stakes, although it is said that the company is undecided whether it wants or needs to scale back the amount available for institutional investors. Similar to last year's jumbo Chinese privatizations, it is also said to be highly likely that the retail component will only amount to 5%.

General market sentiment towards China should further play heavily in the company's favour compared to late 1999 when many accounts and particularly those in the US, demanded a China discount to the consternation of the Mainland government, which was said to have refused to factor it into indicative pricing. Since then, agreement on WTO entry and the snowballing success of subsequent privatizations has made the China factor a positive rather than a negative.

So too, while oil prices are widely predicted to be on the decline, so far this has not shaped up to be the major concern it was in 1999, when prices climbed from $11 per barrel at the beginning of the year to $25 at the end. At the time, an oft-heard argument on the part of investors was that they were not going to be suckered into buying an oil stock when prices were at higher levels than anyone could have imagined.

Yet in 2000, they continued to climb up past the $32 per barrel mark and with them so did CNOOC's profits.

Many conclude that having failed to embrace CNOOC the first time, investors will be more willing to listen the second. "In 1999, investors had a certain view of China and never really got past their concerns to look at the company itself in any detail," reports one market player. "Those that did found it hard to believe that a PRC oil company could be so efficient and well run. There were just too many new things for them to take in at once."

Revenue-sharing rights

Unlike virtually all other State Owned Enterprises (SOEs), for example, CNOOC has never had to rely on government funding and operates on a standalone basis. What it does receive, on the other hand, is a hidden subsidy in the form of its revenue-sharing agreements with foreign oil companies.

Market observers say that while the mechanism allowing CNOOC to receive 51% of E&P revenue is not unusual, the comprehensiveness with which it is applied and the high percentage which the company receives is very unusual. In Indonesia, for example, only 10% is given up by foreign oil companies and in Thailand, revenue-sharing rights are only applied across a couple of oil fields.

But as one analyst argues: "The policy should be viewed positively because it has fostered profitability and creditworthiness in a very young company. In a short period of time, it has enabled CNOOC to build up a pretty balanced portfolio in which about 50% of revenue comes from revenue-share agreements and about 50% from its own E&P activities."

However he continues: "Investors have shown that they do no want to buy the potential upside offered by the revenue-sharing rights. While CNOOC may have a potential drilling area of 1.2 million square kilometres, who's to say how much oil may actually be there, particularly since the density of wells per square kilometre is so low. It could play either way."

Some investors are also said to have quibbled about a disclosure that CNOOC has recently paid a special dividend of 6.4 billion Yuan ($773 million), the majority of which went to its parent and equates to about 80% of profits over the first nine months of 2000. "If CNOOC is truly not like other SOEs and there are no legacy issues, why then is it writing such a large cheque?" asks one.

Roadshows for the 1.64 billion share deal (incorporating 200 million secondary shares) are provisionally slated to begin the week after Chinese New Year, for pricing around February 19. In addition to the Hong Kong retail tranche, there will be three separate institutional tranches spanning Asia, Europe and the US.

Alongside the leads, co-leads are BNP Paribas Peregrine, Casenove, CLSA, Deutsche Bank, DKB, JP Morgan and UBS Warburg, with co-managers numbering ABN Amro, Core Pacific, ICEA, Indosuez WI Carr, Lehman Brothers and Nomura.

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