Dongyue to raise $176 million from IPO

ChinaÆs largest refrigerant and polymer producer plans to expand into the profitable silicone segment following its Hong Kong listing.
ChinaÆs leading refrigerant and polymer producer Dongyue Group kicks off the roadshow for the institutional portion of its Hong Kong initial public offering today, aiming to raise up to HK$1.37 billion ($176 million).

Dongyue is the largest producer of fluoro chemicals in China, controlling 26% and 28% of the domestic market for refrigerants and fluoropolymers respectively. The companyÆs fluorochemicals business produces fluorocarbon chemicals like HFC-134, which is mainly used in automobile air conditioners, and HCFC-22, which is used in refrigerators, air conditioners and as a feedstock for fluoropolymers. Fluoropolymers products include PTFE and HFP which are widely used in the construction, electronics, automobile and aerospace industries.

The company is offering 520 million new shares, or 25% of its enlarged share capital pre-shoe, with 90% earmarked for institutions and the rest for retail investors. The retail portion is subject to normal clawback triggers, which will increase the retail tranche to 50% of the total deal from an initial 10% if it is more than a hundred times subscribed. A 15% greenshoe could increase the deal size to a much as $202.1 million. Citi is the sole bookrunner.

Dongyue is moving into the silicone industry with a 60,000 metric tonne per year silicone monomer capacity starting late this year and another 100,000 metric tonne per year starting at the end of 2008. Silicone products are broadly used in diverse sectors from personal care to pharmaceuticals, construction, electrical, and manufacturing. According to a research report on Dongyue, silicone demand growth over the next five years in China is expected to remain around 15% per year or higher, as the market is still at an early stage of development.

According to the research report, refrigerants accounted for 79% of the companyÆs sales in 2006; another 21% came from the sales of polymers. The new silicone business is expected to become a key driver of both revenue and operating earnings, accounting for 12% and 22.8% in 2008 and 20% and 28.9% in 2009 respectively.

Dongyue has set a price range of HK$2.05 to HK$2.63 per share for its offering, which values the company at a multiple of 12.5 to 16 times its 2008 earnings, according to a source.

The research report lists silicone producers Zhejiang Xinan and China Bluestar, which trade in ChinaÆs A-share market, as possible comparables. Both companies have foreign technology partners and track records in the silicone industry and currently trade at a 2008 price-to-earnings ratio of about 30 times. Companies with dual A- and H-share listings trade at an average 32% discount in the H-share market versus A-shares, which suggests Xinan and China Bluestar would fetch a P/E of about 21 times in the H-share market. It also suggests that Dongyue is being offering at a discount of as much as 40% to these comps.

Looking at other Hong Kong-listed Chinese chemical and fertilizer manufacturers, China BlueChemical and Sinopec Shanghai Petrochemical trade at 2008 earnings multiples of 18.1 and 52.1, respectively.

After posting steady gains since mid-August, both these companies have fallen since the beginning of this month with China BlueChemical down more than 25% from its peak to last FridayÆs close of HK$4.95. Sinopec Shanghai Petrochemical has shed 30% to its last close of HK$4.83, in tandem with the recent volatile markets.

Moving towards the silicone industry will generate new income streams for Dongyue, but it is not be without risk. In fact, the industry is highly concentrated with the top five producers, including China Bluestar, controlling more than 80% of the global market. Another key risk is the Montreal ProtocolÆs restriction imposed on the consumption and production of HCFC-22, a refrigerant product which accounts for 39% of the companyÆs revenue in 2006. China has reduced its export tax rebate for HCFC and any further reduction could channel more output into the domestic market, thus suppressing prices. The research report projects a 23% decline in HCFC-22 prices on the back of slowing export demand and new supply.

Another key product of the company, HFC-134a, is favoured as a long-term solution under the Montreal Protocol, but being a greenhouse gas it is not encouraged by the Kyoto Protocol.

Apart from expanding into the silicone industry, the company also plans to double its fluoropolymer production from 10,000 tonnes in 2006 to 20,000 tonnes in 2009, which should allow it to reduce its reliance on external sales and become more integrated. The company also intends to increase its self-sufficiency of intermediate products (AHF and CFM) in fluorocarbon production to further improve cost competitiveness. It plans to expand AHF and CFM production capacity from 58,000 tonnes and 64,000 tonnes respectively in 2006 to 95,000 tonnes and 117,000 tonnes of capacity in 2009. The report estimates this will reduce DongyueÆs external raw material costs as a percentage of overall costs from 60% to 40%.

Before listing, International Finance Corporation holds 6.8% of the company and Baring Private Equity has a 12.6% stake, while the management team collectively holds 19.4%. After the offering there is a six-month and 12-month lock-up period for strategic shareholders and the management respectively.

The proceeds will be primarily spent on the expansion of production capacities, construction plans of silicon products as well as equipment upgrades.

The offering will be priced on November 30 and the trading debut is scheduled for December 7.
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