Fosun offers A-share exposure to foreign investors

The Chinese conglomerate with investments in steel, property and pharmaceuticals seeks to raise up to $1.4 billion.
Even in the midst of the flurry of Chinese companies tapping the IPO market in Hong Kong at the moment, Fosun InternationalÆs up to $1.4 billion offering stands out as something of a rarity.

A Mainland conglomerate with several listed companies in its portfolio, the IPO candidate belongs to a breed of companies which - with a few notable exceptions such as the Cheung Kong group - has lagged the broader market performance in recent years as investors have preferred to create their own portfolios. The idea has been that by buying the listed subsidiaries directly, they would be able to avoid the holding company discount typically associated with these types of companies.

The conglomerate or investment company model was highly popular among the Hong Kong-incorporated units of state-owned Chinese firms (the red chips) in the 1990s, but in recent years many of those have been forced to restructure and streamline their businesses after investors turned their back on them, arguing they were too diversified.

The Hong Kong-based conglomerates, on the other hand, tend to consist primarily of property developers with a few small businesses on the side.

Fosun offers something fairly unique, however, as it focuses its investments in Mainland enterprises and A-share listed companies that are otherwise out of reach for international investors without access to a qualified foreign institutional investor (QFII) quota.

ôItÆs a good, simple idea. If they can get people exposure, IÆm sure they will do well on the back of that, but the whole business model of having huge business lines wouldnÆt make sense these days,ö says one market watcher.

FosunÆs main businesses at present are steel (which last year accounted for 73% of revenue and 54% of net profit), property development and pharmaceuticals and include stakes in Hong Kong-listed real estate developer Shanghai Forte Land and gold miner Zhaojin Mining, as well as in Shanghai-listed Nanjing Iron & Steel. It also has interests within retail, natural resources and financial services.

According to sources, the companyÆs aim is to continue to expand this portfolio and create additional value by investing in and improving the operations at companies in various sectors that are currently state owned. Incentive programs that allow the management as well as subsidiaries and associates to grow with the company are an important means to achieve this. The final step is to realise this value through the stock markets.

Future investments will focus on raw materials and the financial services space where it already holds a 25.4% stake in Tebon Securities, a privately-owned investment bank and brokerage firm with a full securities license in China. The additional capital raised from the IPO will put it in a good position to expand within these areas, the sources say.

ôIn addition to fast economic growth, significant fundamental changes are going on in China, which is transforming from a government-planned economy to a market-oriented country, with increasing investment opportunities available for non-state-owned enterprises,ö according to one syndicate research report.

Fosun is already the largest privately-owned conglomerate in China and one syndicate research report notes that it is a ôvery active manager of its diverse portfolio and has a very strong record in capital allocation and investment timing.ö It can also be expected to be more aggressive in capturing M&A opportunities than its red-chip conglomerate peers, which are almost all state-owned.

On his part, Chairman Guo Guangchang likes to refer to the company, which was founded by himself and three fellow entrepreneurs, as a Chinese ôBlackstone.ö Whether this is a fair representation or not, the comparison with the US private equity buyout firm is bound to capture the imagination of investors.

Certainly, the company has already attracted the attention of the Hong Kong tycoons, who are among 11 individual and corporate investors who have agreed to invest $20 million each into the IPO.

The cornerstone tranche will account for between 15.7% and 21% of the total deal, depending on the final pricing and should help instill confidence in the deal among other investors. The cornerstones, who have committed not to sell their shares for six months, include frequent IPO investors Li Ka-shing of the Cheung Kong Group, Henderson Land Development Chairman Lee Shau Kee and Chinese Estates executive director Joseph Lau; the Government of Singapore Investment Corporation (GIC); as well as China Pacific Insurance and China Life Insurance among others.

Fosun is selling only 20% of the company, or 1.25 billion shares, as the expected freefloat of above HK$10 billion (especially if the greenshoe is exercised) has enabled it to obtain a waiver from the otherwise required 25%. The fact that the four partners, who own 100% of the company now, are choosing to hang on to as much of the business as they are allowed post-listing suggests they are optimistic about the future outlook.

The shares, which are all new, are offered in a price range between HK$6.48 and HK$8.68. Including the 15% greenshoe the total offering size could top HK$12.45 billion ($1.6 billion). As usual, 10% of the offering will be set aside for retail investors, but standard clawback levels apply in case of strong demand and could boost this portion of the deal to 50%.

China International Capital Corporation, Morgan Stanley and UBS are joint bookrunners for the offering, which kicked off the institutional roadshow yesterday.

The price range values the company at 13.2 to 17.4 times its 2008 earnings, according to consensus syndicate projections. The estimates are based on sum-of-parts valuations with a 10%-15% IPO discount on top. This compares with a 2008 price-to-earnings ratio of about 15-16.5 times for red-chip peers Citic Pacific and Shanghai Industrial.

The current range is quite a bit higher than the PE multiples of 8-12 that were talked about earlier and which would have meant a deal size closer to $800 million.

At the current deal size of $1.04 billion to $1.4 billion, Fosun could become the third biggest IPO in Hong Kong this year after China Citic Bank and real estate developer Country Garden, which raised $4.25 billion (H share portion only) and $1.9 billion respectively. However, Fosun will have to price its deal at the upper end of the range or exercise most of the greenshoe to ensure it surpasses the $1.3 billion raised by shoe manufacturer and retailer Belle.

According to sources familiar with the offering, the increase of FosunÆs offering is a reflection both of the investor interest in the deal and the recent market gains. However, the fate of the A share market in particular does appear to hang in the balance at the moment, which could make this a particularly challenging time for an A share focused investment company to come to market.

The composite indexes in Shanghai and Shenzhen dropped 3.7% and 4.5% respectively yesterday after the central bank governor said he cannot rule out further interest rate hikes. There were also spreading concerns about further government measures to curb irrational price gains in the market.

Syndicate research also note that much of FosunÆs current portfolio is cyclical and directly exposed to macro-tightening in China, which suggest there will be a degree of uncertainty to any earnings forecasts.

ôA downturn in ChinaÆs economy or a significant change of government policy, for example credit tightening, an official clampdown on the property market, or price cuts for medicine, may adversely affect FosunÆs business and profitability,ö the earlier mentioned research report argues.

As a base case scenario, the analysts at one of the syndicate banks forecast a net profit growth of 81% in 2007, followed by 51% in 2008 to Rmb2.99 billion. Revenues are expected to increase by 36% this year and by 14% in 2008 due to strong growth in the steel and property business.

Among other risks is the groupÆs complex corporate structure, with multiple layers of holdings and cross-holdings, which may be due to capital scarcity and a desire to grow company through the use of leverage. However, the result is relatively low transparency. The company also actively manages selective associates and aggressively uses their balance sheets to expand and grow the business. According to the syndicate research report, there is limited information available about off-balance sheet liabilities and cash flow in these associates.

ôIn this sense, the current high gearing ratio for the company and its segments could be substantially underestimated,ö it argues.

At the end of 2006, the net gearing post minorities stood at 351%, down from 442% in 2004. It is expected to fall to about 54% by 2008, partly as a result of the management using some of the IPO proceeds to pay down debt.
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