Bankers say the current market conditions offer a window of opportunity for companies that wish to go public after a highly volatile first quarter that saw six companies call off their initial public offerings before pricing in Hong Kong alone. However, the number of companies that have started pre-marketing or are already on the road meeting institutional investors has grown significantly over the past couple of weeks, which means competition for funds is also heating up. This could make it tough for companies that donÆt have a unique story to tell investors and suggests that sizeable IPO discounts will remain a feature for some time yet.
Perhaps to improve its chances and to ensure the deal comes at the ôrightö valuation, pre-marketing for Wah Kwong will continue into this week. Analysts have already been speaking to potential investors for a couple of weeks, but sources close to the offering say some fund managers who specialise in the shipping sector havenÆt been available until now.
Hong Kong-based Wah Kwong is riding on the back of the continued strong demand for commodities in China and other emerging markets, but it also has one of the youngest fleets in the world, which means it is more cost efficient than some of its larger rivals, has better margins and generates higher returns on equity. Its business model is also highly conservative, with all its ships being chartered out on long-term contracts of up to five years. While this means that it is unlikely to capture the full benefits of the gains in freight rates in the spot market, it also means that it has high earnings visibility for the next couple of years and is less likely to suffer if the bulk shipping sector were to reverse its current upward trend.
The company has also made it part of its business model to sell older vessels in the second-hand market, thus realising gains when asset prices are high. In fact, in the 2005 fiscal year (ending in March, 2005) as well as in fiscal 2007, revenues from disposals were the companyÆs largest source of income. ôAs this is viewed as a core business area of the company, we believe that recent vessel price appreciation, underpinned by tight shipyard availability, local currency appreciations and robust commodity demand, should be more valuable to Wah Kwong than to its peers,ö one syndicate research report argues.
However, another analyst argues that income from disposals is also unstable, unpredictable and ôhighly dependent on timingö, and adds that the gross profit margin on these sales has been trending lower even since the fiscal year ending in March 2006.
Of the companyÆs 11 ships, seven are bulk carriers that transport cargoes like iron ore and coal to China and other Asia-Pacific markets from South Africa, Brazil, Australia and India. The 11 ships on order û which will be delivered starting from the end of 2008 û are all bulk carriers, reflecting the fact that this part of the market is expected to remain buoyant. The company is expected to generate as much as 67% of its revenues from bulk shipping in the current fiscal year. The tanker segment, on the other hand, was the worst performing part of the shipping industry last year with falling rates. However, a regulatory change in 2009 that will force all tankers to have a double hull is expected to improve the supply-demand balance and help freight rates to recover. The companyÆs four oil tankers have a combined capacity of 995,000 dead-weight tonnes (dwt).
The rather modest capacity makes Wah Kwong significantly smaller than other Hong Kong-listed ship owners and operators. On the bulk side China Cosco operates 423 vessels, China Shipping Development 135, Sinotrans Shipping 26 and Pacific Basin 83. And on the tanker side, China Shipping DevelopmentÆs fleet has a capacity of 3.7 million dwt, while Sinotrans has a capacity of 1.4 million tonnes.
However, the average age of 2.3 years for Wah KwongÆs fleet compares with between seven and 18 years for the other bulk shippers and 10 to 14 years for its tanker rivals.
A source says among the Chinese operators, China Shipping Development is the best comparison since it has a similar mix of bulk carriers and tankers, while Pacific Basin operates only in the bulk segment and Sinotrans and Cosco are also active within container shipping. And while the other operators may be larger, the syndicate research reports argue that Wah Kwong should trade in line with or at a P/E premium to its peers because of its younger fleet, asset management strategy and lower operational leverage. However, that assumption does not, of course, include the need for an IPO discount.
As of last Friday, China Shipping Development traded at a 2008 P/E multiple of 11.1, China Cosco was at 9.8 times, Sinotrans at 7.2 times and Pacific Basin at 9.2 times.
Syndicate analysts argue that Wah KwongÆs aggressive fleet expansion will help underpin strong growth in the coming two years, especially since the charter that are up for renewals in 2008 and 2009 should be able to be secured at substantially higher rates than the existing contracts. The company has also locked in 88% of its capacity for fiscal 2009 and 47% for fiscal 2010. One analyst expects earnings will expand at a compound annual growth rate of 23% from fiscal 2008 onwards, following about 10% growth to a projected $36 million in the year just ended.
Among the other arguments for why to invest, sources say, is the combined experience of the companyÆs owners and management. The company is majority-owned by the Chao family, which has been in the shipping business for more than 50 years, accumulating valuable knowledge of how to read the market and maximise returns. Evidence of this is that the company ordered the 11 new ships currently in its order books before the strong pickup in demand for bulk shipping last year, thus ensuring that it was able to use experienced shipyards that are likely to deliver on time.
Companies that placed their orders at the height of the market found that these shipyards were already at full capacity and were forced to rely on newcomers to the market which are more likely to run into supply shortages of key components like engines and suffer from the rising raw material costs. An industry body estimates that 20% of new bulk carrier orders will be delayed or not delivered at all as a result of this. If correct, this would help to limit the supply and have a positive impact on shipping rates.
ôPeople have been worrying about oversupply, but they donÆt realise that there are a lot of ship orders being cancelled,ö says one source close to the offering. ôMany new shipyards are suffering from inadequate financing and have had to cancel contracts. Meanwhile, raw material prices, especially steel prices, hurt their margins and some shipyards prefer not to honour their contract rather than going through the whole process and build something that will be unprofitable.ö
The sector is not without risks though, as it is highly cyclical, even if the increasing demand for commodities in China and India has helped to prolong the current uptrend in the dry-bulk segment of the market. Wah Kwong also derives about 90% of its revenues from a handful of customers, which could leave it very exposed if one or two of them were not to renew their long-term contracts.
Wah KwongÆs predecessor, Wah Kwong Shipping, was listed in Hong Kong already in 1973, but after running into financial difficulties in the 1980s and a restructuring in 1999 that saw Belgian shipping company Compagnie Maritime Belge (CMB) become the majority shareholder, the company was taken private in 2000. A year later the Chao family bought out CMB and once again resumed control of the company. Aside from the chairman, who represents the third generation of the Chao family to run the company, Wah Kwong is now led by professional managers, several of whom have experience from other shipping companies.
The offering will comprise about 25% of the company. Most of the shares will be new, although sources say the chairman may also sell a small portion of his holdings. Cazenove and Anglo-Chinese are joint bookrunners.
Cazenove was also the sole bookrunner for the $80 million IPO for fashion accessory and jewellery designer Artini China, which started trading in Hong Kong last Friday. The stock fell 9.9% from its HK$2.22 IPO price to finish the day at $2.
Among the other listing-hopefuls currently in the market, sportswear designer and retailer Xtep International Holdings and sportswear distributor Pou Sheng Group both kicked off their institutional roadshows on Friday with the aim of raising up to $388 million and $396 million, respectively. XtepÆs offering is arranged by JPMorgan and UBS, while Pou Sheng is brought to market by Merrill Lynch and Morgan Stanley. They will be followed today by China Central Real Estate, which, according to sources, is aiming to raise $200 million to $250 million, also through Morgan Stanley.
Currently pre-marketing are: hot pot restaurant chain Little Sheep, which is hoping to raise about $250 million with the help of Deutsche Bank and Merrill Lynch; industrial company Chongqing Machinery & Electric Co., which is targeting about $200 million through Credit Suisse; and Shandong Chenming Paper Holdings, which has enlisted Macquarie and Guotai Junan for a $400 million IPO.
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