The sale was part of a financing package put together by BOC International to pay for an acquisition of three coking coal mines that was announced about a month ago and followed a similarly sized share placement to a strategic investor earlier in the week. ThursdayÆs placement was completed at a 4.3% premium to the strategic placement, which saw steel manufacturer Shougang Holding (Hong Kong) acquire $265 million worth of shares at HK$4.60 each. Assuming the acquisition goes through and both placements are completed, Shougang will end up with a 9.9% stake in Fushan.
The institutional placement, which was fully underwritten by BOCI and accounted for 9% of the share capital as enlarged by these three events, or 16.8% of the existing share capital, was always going to be the more difficult of the two, given the continued volatility in the market. The HSI fell 2.3% on the day of the placement and has lost 10.7% since Fushan announced the acquisition of the mines on May 22. Demand for coking coal remains strong, however, and in the past couple of months the price has tripled to above $300 per tonne û a new record for the commodity which is primarily used for steel-making.
BOCI and the company management had also laid the ground work since the acquisition was announced by visiting scores of investors in Hong Kong, Singapore, London and Abu Dhabi û complemented by a few conference calls to the US and Japan û to explain the strategy behind the deal and the opportunities that it creates for Fushan. The placement was offered to less than 50 investors and while that decision was likely driven by a desire to avoid having to produce an offering circular, it does indicate that the bookrunner was highly confident that investors would convert their initial interest into buy orders.
In the end, about 35 investors who met the company on the roadshow submitted orders. Some fell out as the deal was priced at the mid-point, and the final allocation was said to have included about 25 accounts û all of which are expected to have invested for the long-term. In any case, this was definitely not a deal for short-term speculation as investors wonÆt receive their shares until late July after FushanÆs minority shareholders get a chance to vote on the acquisition and the financing package, which leaves them exposed in case the stockmarket and FushanÆs share price falls in the interim.
Helping the deal along, FushanÆs chairman Wong Lik Ping bought 100 million shares, or 24.4% of the total offer, which will leave him with 31.5% of the enlarged company.
The placement comprised 410 million new shares, which were offered at a price between HK$4.60 and HK$5.00. The limited orders were largely concentrated in the lower half of the price band and the final price was set at HK$4.80, which represented a 6.1% discount to ThursdayÆs closing price of HK$5.11. The stock rose 4.1% during the day on news of the Shougang investment and in general has been quite well supported since the mining acquisition was announced, resulting in a net gain of 12.8% over the pre-acquisition price of HK$4.53. The stock was suspended on Friday.
Excluding the portion bought by chairman Wong, the deal was more than three times covered. The final demand was heavily weighted to Asia and Europe with participants said to be long-only accounts as well as first-tier hedge funds.
Prior to this deal, Fushan would have been largely unknown to international investors. According to Bloomberg there is no analyst coverage of the stock and while it is active in the highly attractive coking coal industry, it is primarily a processor that is involved in the washing of the coal rather than actual mining. This will change with the acquisition of the three mines from Fortune Dragon, which will increase FushanÆs net asset value by 2.6 times from its current HK$792 million and turn it into an integrated coking coal company with upstream and downstream.
The new businesses have a fair value of HK$11.8 billion ($1.5 billion) as of April 30 this year, as estimated by Greater China Appraisal, and combined revenues of about HK$2 billion in 2007. The latter compares with FushanÆs modest top line income of HK$15 million last year.
Some Hong Kong-based observers have noted that this big an acquisition û the total cost is HK$10.53 billion û will be tough for Fushan to digest. They have also questioned its ability to raise the financing needed to cover the HK$4.86 billion cash portion of the payment. With ThursdayÆs placement, which contributed HK$1.92 billion in net proceeds, that cash is now in hand. The rest of the money will come from the strategic placement (HK$2.015 billion) and a HK$1.2 billion bank loan provided by BOCI.
With regard to the large size of the deal, sources familiar with the company say Fushan knows what it is doing and note that aside from its coking coal processing business, which made a loss last year, it also owns a large mine which it hasnÆt started to develop yet. Through the acquisition of three of Fortune DragonÆs largest mines it will not only get its hands on fully operational assets with a steady cash flow, but will also gain the necessary expertise to develop this dormant mine, which should offer substantial growth potential for the future. In its 2007 annual report, the company said its application for mining rights and other relevant government approvals for this mine are progressing well and it hopes the process will be completed within this year.
The controlling shareholders of Fushan and Fortune Dragon also know each other well as their respective businesses are located close to one another in Shanxi. FushanÆs chairman has a 7.5% stake in Fortune Dragon, which is unlisted and owns about 10-12 mines including the three it is now selling. And since HK$5.67 billion of the acquisition cost will be settled through the issuance of 1.26 billion shares (at HK$4.50 apiece), Xing Libin, who is the controlling shareholder of Fortune Dragon, will end up with a 15.7% stake in the enlarged Fushan, which means he will continue to benefit from the upside of these mines. Essentially, what he has achieved is a backdoor listing of the three mines and the potential to exploit the synergies between two companies whose businesses complement each other well.
In an announcement, Fushan said, for example, that one of the new mines is expected to supply 40% of the raw coal for a new coal preparation facility that it has started to construct, which will have a nominal processing capacity of 3 million tonnes a year and a projected clean coal output of 2.1 million tonnes a year. Production will begin by the end of this year or early 2009.
Meanwhile, the sale of a strategic stake to Shougang is accompanied by an agreement that will see Shougang buy at least 2 million tonnes of premier clean coking coal from Fushan every year, starting from 2009. Aside from contributing part of the financing for the acquisition, this part of the deal will also help ensure part of FushanÆs revenues in the years to come. The three new mines have a combined approved output capacity of 3.6 million tonnes a year, split evenly between them. Two of the mines produce hard coking coal, while the third produces semi-hard coking coal.
ChinaÆs coke industry expanded at a compound annual growth rate of 23.6% from 2003 to 2007, in line with the more than 23.9% CAGR in steel production in the same period. Presenting the rationale of the acquisition to its shareholders, Fushan noted that Shanxi province has the richest coal reserves in China, accounting for close to 60% of the countryÆs total proven reserves, and Liulin County û which is where its three new mines are located û has the highest grade coking coal available in China and the world.
BOCI and Morgan Stanley were joint financial advisers to the company on the acquisition.