Hony offloads 11% stake in CSPC

The private equity firm raises HK$4.095 billion from the sale of 650 million secondary shares in the Chinese pharmaceuticals group.

Private equity firm Hony Capital divested an 11% stake in CSPC Pharmaceutical after Thursday's close in Hong Kong, raising HK$4.095 billion (US$528 million) from the sale of 650 million secondary shares.

Under the lead management of Goldman Sachs, Morgan Stanley and UBS, the group priced the accelerated block at HK$6.30 per share. This represented the very bottom end of a HK$6.30 to HK$6.45 range and an 8.3% discount to the stock's HK$6.87 close.

The order book was said to have closed just over two times covered, with participation from roughly 100 accounts. In terms of allocations, the top 10 investors took 60% of the deal and the top 20 investors, 75%.

By investor type, there was a mix of sovereign wealth funds, long-only funds, existing investors and some hedge funds. The deal equated to 30 days trading volume.

As a result of the deal, Hony Capital's overall stake in the Chinese pharma group has dropped from 62% to 51%. CSPC Pharma is currently controlled through four separate Hony entities and these will now be subject to a 180-day lock-up. There is, however, a caveat allowing the private equity group to sell additional shares to the firm's chairman, Cai Dongchen. 

This caveat becomes effective after 30 days and Dongchen has re-iterated his intention to boost his ownership. In May, he purchased 105.88 million shares alongside a 600 million secondary share sale by Hony, which represented 11.95% of CSPC Pharma's share capital and increased his stake to about 3.5%.

Over the past year-and-a-quarter, Hony has executed four placements in CSPC stock. However, until the current deal, its overall holding in the group always bounced back to the level it was at before because of the conversion of underlying equity linked debt.

The conversion of an $863 million convertible bond into equity has massively increased CSPC's issued share capital from 2.7 billion shares at the end of 2012 to 5.9 billion currently.

The convertible was issued in 2012 alongside a HK$2.271 billion ($290 million) share sale to fund the acquisition of three companies, which transformed the group into an innovative drug developer from a generic manufacturer.

At this point, Hony re-branded it CSPC Pharmaceutical from its original name, China Pharmaceutical Group, which it had purchased from the Shijiazhuang municipal government in 2007 for Rmb870 million.

The convertible bond had a strike price of HK$2.0858 but conversion could only be triggered if the free float was above 25%. This necessitated a number of block trades to reduce Hony's stake below the necessary threshold as each conversion of stock pushed it back up again. 

In April 2013, for example, Hony raised HK$1.2 billion ($154 million) from the sale of a 12.2% stake, which reduced its shareholding from 74.6% to 62.4%. This was priced at HK$3.60 per share, which represented a 10.2% discount to the close. 

Once this lock-up expired, it was back in the market in October 2013 with a HK$2.025 billion deal, which represented 13.07% of the company's issued share capital and reduced its stake from 73.23% back down to 60.16%. This was priced at HK$4.05, a 7% discount to the group's HK$4.35 close.

Then in May, Hony was back again with a HK$4.4 billion deal, which represented 11.94% the company's issued share capital and reduced its ownership from 74.2% to 62.26%. This was priced at HK$6.25, equating to a 7.1% discount to the group's HK$6.73 close. 

Hony has never publicly said what residual stake it would like to retain in the group but the current deal is likely to have removed much of the overhang, which has surrounded the stock. But this has not put a brake on its underlying performance, with the pharma sector massively outperforming both the H-share and red-chip indices over the past 12 months.

Year-to-date, CSPC Pharma's stock price is up 11.1%, although it suffered a period of underperformance after mid-March when it hit a high of HK$8.16. Since the beginning of August, it has once again been exhibiting strong upwards momentum, rising 16.2% so far this month.

At current levels, it is trading at a historically high valuation of 30.26 times 2014 earnings according to Bloomberg. By contrast, the Hang Seng Enterprises Index is up 1% year-to-date.

CSPC's recent trading performance has also been underpinned by interim results this Tuesday, which beat consensus expectations. These revealed a 16.6% jump in net profits to HK$600.7 million and an improvement in its gross Ebitda margin from 30.4% to 37.8% 

Analysts noted particularly strong growth in the innovative drug segment, which saw sales rise 49.3% year-on-year. The group has one of the biggest R&D bases on the Mainland, with 170 products pending, including 41 new class 3 drugs and 14 new class 1 drugs, of which five are undergoing clinical trials.

However, they also caution that as more of these drugs enter the later stage of clinical trials, the company's R&D expenses are likely to shoot up and margins could come under pressure.

A second issue relates to the government's anti-corruption drive, which has caught Glaxo SmithKline in its net. Some analysts believe this may slow down the tendering process across China's provinces, which approve drugs on a province-by-province basis.

Announcing its results, the company said some provinces have announced tenders for the second half, which will help to maintain current profit levels. The group will also launch a new cancer drug this September called Imatinibin.

Its product line spans oncology, dementia, strokes and hypertension.

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