Hong Kong IPO market gets some fertiliser

CNOOC unit China Blue Chemical starts pre-marketing of an up to $400 million IPO with strong backing from strategic and corporate investors.
China Blue Chemical, which starts pre-marketing today (August 28) of its Hong Kong initial public offering, is banking on its modern production facilities and growth projections above the sector average to attract investors.

Having secured a strategic investment from Norwegian fertiliser producer Yara International and with a lot of interest from Hong Kong tycoons, the company is already well on its way to raise the up to $400 million it is seeking. But according to people familiar with the offering, China Blue will limit the sale of shares to Yara û one of the worldÆs largest fertiliser producers - and the local tycoons to about 30% of the total offer to ensure there will be enough shares for other institutional investors as well.

The company, which is a wholly-owned subsidiary of China National Offshore Oil Corp and a sister company of Hong Kong-listed oil and gas producer CNOOC Ltd, uses natural gas to produce 1.8 million tonnes of urea fertiliser (also known as carbamide) per year, making it the second largest producer in China after PetroChina. Urea has become the major global source of nitrogen, which is essential for plant growth.

China Blue is also in the process of quadrupling its production capacity of methanol, which has numerous industrial uses and can also be found as additives in fuels.

The expansion of its methanol business is expected to support earnings growth in the high single digits going forward, compared with flat earnings growth for fertiliser producers as a group, observers say. The company is also seen in a good position to benefit from an expected consolidation in ChinaÆs fragmented fertiliser industry. A few years back it bought a majority stake in Tianye Chemical, a fertiliser business in Inner Mongolia, from the local government and converted it from a petrol-based operation into one that runs on natural gas, boosting its profitability in the process.

ôThe company is looking for (acquisition) targets, but hasnÆt identified any yet,ö says one observer

JPMorgan and UBS are arranging the offering, which will account for about 30% of the compnayÆs issued share capital. All the shares will be new, except potentially the 10% that will go to the National Social Security Fund. There will be the usual 90-10 split between institutional and retail investors, although the exact number of shares to be put up for sale has yet to be decided.

The company and its underwriters are said to be arguing that China BlueÆs state of the art production facilities, which makes it one of the most efficient and profitable companies in the industry, justifies a premium over its domestic peers. An experienced management and the added growth driver from its methanol business are also seen to support that view.

However, the final valuation will depend on the demand and price sensitivity of investors. This has still not been put to a real test since the equity market correction in May and June, which forced several companies to delay their IPOs. Since then, the secondary market has recovered, but the primary market has remained quiet because of the summer holiday period.

Key comparables for China Blue include China-listed Lu Tian Hua and Yun Tian Hua, which are large-scale, natural gas-based urea producers that trade at 2006 P/E multiples of 10-12 times. Canada-based Agrium, which aside from nitrogen fertilisers also makes agricultural nutrients based on phosphate and potash and has a retail operation that markets seed and crop protection products, trades at a forward PE in the mid-teens, while Yara fetches about 8-9 times this yearÆs projected earnings.

A second way to value fertiliser companies is based on EV/EBITDA multiples and here the valuation between international and domestic Chinese producers is much more consistent at about seven times. In 2005, China Blue generated recurrent net earnings of about Rmb820 million ($103 million) on sales of around Rmb2.4 billion ($300 million).

Observers say the company is in a better position to withstand rising natural gas prices than many of its peers, having secured a long-term contract for the raw material from its parent. Companies without such long-term supply guarantees will risk seeing their profits squeezed if the cost of natural gas was to start heading higher again. At present spot prices are up to 30% below where they were 12 months ago.

However, one observer pointed to the government controls on natural gas prices in China, saying this does make mainland fertiliser producers less exposed to such risk.

Whether investors are prepared to buy into the IPO or not will likely depend on their view on urea and methanol prices with some analysts arguing that urea prices may be about to see a downturn after being on the rise for that past couple of years. However, urea prices in mainland China are still a bit lower than prices in the international market, which means international market prices need to fall quite a bit before it will have a direct impact on China-based producers, the observer says.

The company currently has two urea production facilities in Hainan and Inner Mongolia, which sources natural gas from CNOOC and PetroChina, respectively. It also has a methanol production plant in Inner Mongolia with a production capacity of 200,000 tonnes per annum and is currently constructing a second one in Hainan, which will have a capacity of 600,000 tonnes when it starts commercial production in 2007.

Proceeds from the IPO will also go towards the construction of a production facility for POM plastics that will make use of some of the companyÆs methanol, which is a key raw material for this type of plastic. Some of the money will also been used to repay existing loans.

One person familiar with the offer say Yara is seeking a strategic alliance with China Blue and has been in discussions ôfor some timeö about the size of its equity investment. The Norwegian company will ôprobably buy about 10% of the deal,ö the source says.

Meanwhile, up to 20% of the offer will be set aside for three or four local tycoons with a couple said to have reached an agreement with the company already.

Pre-marketing will last for two weeks, with the formal roadshow set to launch on September 11. Pricing is expected on the September 22 and the trading debut is currently scheduled for September 29.
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