First dual Nasdaq/GEM listing by TOM Online

For the second time in a week, a China tech play is snapped up by momentum hungry investors.

Tom Group spin-off TOM Online priced its IPO at the top of its indicative range on Friday, raising $192 million pre-greenshoe. Pricing came in at HK$1.50 (HK$1.515 post-brokerage fees and taxes), after retail books closed 96 times oversubscribed and institutional books 44 times.

Post greenshoe, the group could raise up to $221 million.

Because of the group's GEM listing, bookrunners Citigroup and Morgan Stanley had complete control over the allocation process and were not subject to the usual clawback mechanisms of the main board. As a result, they decided to increase the retail tranche from 10% to just 20%. A further 7% was allocated to US retail, 12% to the leads' own high net worth client bases and the remaining 61% to institutions.

Of the institutional allocation, 45% of demand came from the US, 30% from Asia and 25% from Europe. There was no cap on orders and specialists say most investors "behaved sensibly", although one Asian account put in an order for the size of the whole issue.

"We could have raised the retail allocation to 30% from 20%," says one specialist. "But with institutional interest so strong, we decided to make sure the main funds weren't disappointed. They got $5 million each."

He added that a bigger institutional tilt should also ensure the deal will not be quite so heavily flipped on its first day of trading. There are some, however, who believe that many institutions are currently behaving just like speculative retail investors and are only participating in the current rash of China tech IPO's to make a quick buck.

The decision to adopt a dual listing was also relatively unusual for such a small deal. But as one banker points out, Hong Kong is the place for China-related research, while Nasdaq is where comps Netease, Sina and Sohu have produced up to 640% returns for investors in the past year.

The issue was priced at 21 times 2004 earnings, at the high end of the 16 to 21 times indicative range. Some analysts are forecasting that 2004 earnings will top $40 million, versus fourth quarter 2003 earnings of $9 million.

In terms of the main comps, Sohu - considered to be the weakest of the Nasdaq-listed portals - was trading at 23 times 2004 earnings at the time of pricing, while Netease was at 30 times and Sina 37 times. Supporters hope TOM Online will trade up to Netease's level in the secondary market.

"This is by no means an aggressive valuation," says one observer. "Not when you consider the strong earnings growth predicted for this year. The valuation is also relatively conservative because Tom Group wants to make sure TOM Online trades up in the aftermarket, since this will help its own valuation."

Sources close to the deal have been keen to stress that TOM Online is not a pure-play wireless data provider, although this is currently where 90% of its revenue comes from.

"Tom Group has the 16th biggest portal in the world," says one. "Indirectly TOM Online already has a huge online presence as well as the biggest share of the 15 to 25 year-old market.

"TOM Online is not interested in relying exclusively on wireless data services," he adds. "This year the company wants to build up its portal presence and diversify into online gaming and advertising."

Yet as many have pointed out, the main weakness of the pure wireless data plays is their dependence on the mainland telecom companies. The latter currently receive 15% commission for collecting revenue from the portals' customers.

The phone operators are vital to the business model because customers are charged for transactions with the portals via their mobile phone accounts. This means there is nothing to prevent the telecom companies from sharply upping their rates, or more simply conducting the business themselves.

Nevertheless supporters believe TOM Online's business model lends itself to strong earnings growth.

"There is a multiplier effect at work since the model is so asset light, but the scalability of the service so high," says one. "I think rising earnings will help push the P/E ratio up into the late 20's and early 30's."

TOM Online invested just $5 million in capex last year. But demand for valued-added data services is rising fast on the back of 15% to 20% annual growth in mobile subscriber numbers per year.

In addition, the business model is not as vulnerable as others to price-cutting since prices are already very low and companies rely on volume to generate revenue.

But Davina Yeo, a wireless and networking expert at IDC in Hong Kong, warns that the sector is volatile and will eventually see a shakeout.

"There are some 500 service providers in China, and certainly not everybody will survive," she says. "Brand name will be very important in deciding the winners."