Cofco spin-off seeks HK listing to fund expansion plans

The company's move into biofuels drives investor interest in the $332 million IPO. A strategic investor from Japan will take $65 million worth of shares.
China Agri-Industries Holding has kicked off the institutional roadshow for what will be the first Hong Kong IPO by a Mainland state-backed company this year. The listing candidate is looking to raise up to HK$2.6 billion ($332 million) which will also make it the largest Hong Kong listing so far this year, ahead of China Huiyuan Juice GroupÆs $308 million.

The deal could in fact end up being even larger because of an offer to the shareholders of its Hong Kong-listed sister company to either receive shares in the listing candidate on a one-for-one basis or to get the equivalent amount in cash. If they choose cash, the company, together with Goldman Sachs as the global coordinator, will make a decision whether to increase the offering to meet those cash payments.

In theory, this could see the number of shares on offer more than double, although this would be highly unlikely as investors typically choose to receive shares in order to benefit from the potential upside after the listing and the fact that they are getting guaranteed IPO allocation. However, as the offer to take shares isnÆt available to overseas investors at least some portion of the offer will be taken up as cash.

Effectively a spin-off from Hong Kong-listed Cofco International (although the two have become sister companies following a group restructuring), China Agri is ChinaÆs largest processor of agricultural products. It is, however, its recent move into the production of biofuels that is expected to hit home with international investors.

ôThe feedback so far is that it is the fuel ethanol business that is of most interest. There are other parts of the business that generate larger profits at the moment, but a significant amount of the IPO proceeds will be dedicated to expand the biofuel business,ö one source familiar with the marketing process says.

China AgriÆs biofuel and biochemicals division accounted for no more than 7% of revenues and 25% of Ebit in 2006, according to syndicate estimates, but this is expected to increase to 18% of revenues and 51% of Ebit by 2008 as new capacity comes on stream. The division will absorb 71% of the Rmb6.1 billion in capital expenditures that the company is planning for 2007 and 2008.

The companyÆs other four divisions will also be expanding capacity in the coming two years, however, and together with a forecast margin improvement, this will set the scene for strong earnings growth in years to come, syndicate analysts argue.

However, the offering is not without risks as any delay in the planned expansion would have negative implications for the projected bottom line. ChinaÆs biofuels industry is also highly regulated and future decisions by the government related to this area could have significant impacts on both margins and the competitive environment.

At present, biofuel producers need a license for each plant and another if they want to upgrade capacity. They are also allocated a certain area in which to sell their products to avoid competition. The regulator, NDRC, also sets selling prices and provides tax exemptions and other subsidies to fuel ethanol producers to compensate for the restrictions on supply.

China Agri, which together with the Cofco group has stakes in three of the four existing fuel ethanol plants in China and a license to construct a fifth, is in a strong position right now. And the managementÆs belief is that the governmentÆs aim to develop both the agricultural sector and alternative energies will ensure that at least for the foreseeable future any policy changes will continue to benefit the existing players and make sure they are profitable.

ôThe expectation is that when the current three-year subsidies are up for renewal in 2008, the government will opt to maintain the status quo for another three years,ö one observer says.

China Agri is offering 697.8 million new shares, or about 20% of the company, at a price between HK$3.10 and HK$3.72, which puts the total deal size at $277 million to $332 million. If the 15% greenshoe is fully exercised the maximum amount could expand to $382 million. This assumes no increase as a result of the offer to CofcoÆs shareholders. That offer is equal to 718 million shares.

Cofco investors have until Friday (March 2) to decide whether to take cash or shares and the decision by the company and Goldman on weather to increase the IPO or not will have to be made before the launch of the 10% Hong Kong retail offering on March 8.

BOC International is joint bookrunner on the deal together with Goldman.

As part of the IPO, China Agri has agreed to set aside Ñ7.9 billion ($65 million) worth of shares for strategic investor Mitsubishi Corp. at the IPO price. According to sources, the Japanese conglomerate has been in talks with China Agri for a few months about a potential joint venture but while the investment amount has now been agreed, it is still unclear exactly within which areas the two companies will cooperate. Mitsubishi currently has a rice and wheat trading business, which fits well with part of China AgriÆs operations.

Aside from the biofuel and chemicals business, the listing candidate is also active within oil seed processing, rice trading and processing, brewing materials and wheat processing. The largest of the divisions at present is oil seed processing, which accounted for 59% of the revenues and 41% of Ebit in 2006, according to syndicate estimates. But while revenues are expected to remain high at 62%, the divisionÆs profit contribution is expected to fall to 29% by 2008 as the biofuel production becomes more prominent.

The indicative price range values the company at 14.5 to 17.4 times its 2007 earnings, as based on average syndicate forecasts. This compares to a 2007 PE multiple of about 13.4 times for US-based Archer Daniels Midland, which investors view as the closest comparable given that both companies are active within the processing of agricultural products û mainly oil seeds û as well as the production of biofuels and biochemical products.

Other comparables typically operate only in one of these areas. Syndicate analysts argue that China Agri deserves to trade at a premium to Archer Daniels given that the latter is forecast to see a net profit CAGR of only about 12% in 2006-2008 compared with expectations that China Agri will deliver 24% earnings CAGR in the same period. Archer Daniels is a much more established player, however, and at a market cap of $22.3 billion, it is almost 14 times larger than its Chinese rival.

Regional competitors within the biofuel and biochemical sector include Hong Kong listed Global Bio-Chem, which trades at a 2007 PE multiple of about 8.5, Singapore-listed China Sun Biochem, which trades at 4.9 times and Shanghai-listed Anhui Fengyuan Biochemical, which trades at 25.9 times its projected earnings û affected no doubt by the current imbalance between supply and demand for Chinese A shares.

Sources familiar with the pre-marketing say investors do not look at either of these companies as serious comparables, however.

Arguably, China Agri has aggressive expansion plans. By 2008 it plans to have added four more biofuel plants that will boost its production capacity to 1.08 million tones from 180,000 tons at present and three new plants to produce corn-based biochemical products. Outside the biofuel and biochemicals division it is looking to boost its oil refinery capacity by 43%, its rice processing capacity by 68%, its brewing materials capacity by 89% and its wheat processing capacity by 50% - all by the end of 2008.

While a syndicate research report projects that this will drive net profit to HK$931 million ($119 million) in 2008 from HK$255 million in 2005 and an estimated HK$639 million in 2006, it will also result in a significant increase in capital expenditures. Some 85% of the net proceeds from the IPO will go towards this business expansion, split 40% for fuel ethanol production and 45% for biochemical production, with the remainder to be used to develop the oil seed business.

Even so, the report suggests that China Agri will need to increase its borrowings to HK$8.3 billion by the end of 2008 from HK$3.4 billion at the end of 2005 to meet its objectives, which will see its financial costs rise to HK$379 million next year. Its net debt-to-equity ratio will more than double to 107% from 51% at the end of last year.

Investors will also have to take into account the risks associated with volatility in commodity prices which has the ability to throw off any long-term earnings projections.

Still, observers argue that the strong consumption growth in ChinaÆs food and beverage industry should provide a positive backdrop for the companyÆs core businesses while it builds up its new biofuel capacity over the next couple of years.

The Hong Kong retail offering will close on March 13 and the final price will be determined the following day, San Francisco time. The trading debut is scheduled for March 21.

The companyÆs ultimate parent, China National Cereals, Oils & Foodstuffs (Cofco), is a state-owned enterprise that is involved in a wide range of businesses which also include hotel management, real estate development, logistics and financial services.

¬ Haymarket Media Limited. All rights reserved.
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