Huishan Dairy kicks off IPO of up to $1.3b

The Chinese milk producer has the support of three cornerstone investors and people close to the situation say the deal was covered on day one.
Huishan Dairy will be a test of investor appetite after the secondary market correction in June and the summer-related slow-down in capital markets activity in August.
Huishan Dairy will be a test of investor appetite after the secondary market correction in June and the summer-related slow-down in capital markets activity in August.

China Huishan Dairy Holdings, a vertically integrated Chinese milk producer, on Tuesday launched the institutional bookbuilding for its initial public offering of between HK$8.64 billion and HK$10.11 billion ($1.11 billion to $1.30 billion).

It is the largest IPO to hit the Hong Kong market since May when Sinopec Engineering and China Galaxy Securities raised $1.8 billion and $1.1 billion respectively. Those deals remain the two largest listings in Hong Kong so far this year and Huishan Dairy will be a test of investor appetite after the secondary market correction in June and the summer-related slow-down in capital markets activity in August.

As usual, there is a pretty extensive pipeline for the final four months of the year and a successful transaction is important in order to give other issuers the confidence to launch and for investors to commit capital to new and untested names.

And it is looking good so far. According to people close to the situation, Huishan Dairy attracted quite a lot of orders shortly after launch and by Tuesday afternoon the four bookrunners told investors that the deal was fully covered. This includes a pre-launch commitment from three cornerstone investors that will buy between $196 million and $214 million worth of shares, depending on the final price.

Meanwhile, snack food producer Tenwow’s smaller IPO, which was due to close at the end of the US business day on Tuesday, is multiple times covered and likely to price at the top, according to people close to the situation. The Chinese company is seeking to raise up to $203 million and has secured cornerstone commitments for almost half of that. It will be the first company of size to list in Hong Kong post summer.

One banker noted that both Tenwow and Huishan Dairy are benefiting from a theme of “going long China” that has been gaining traction recently. As part of that, investors are switching from defensive stocks into higher beta names, including various consumption plays.

The renewed appetite for Chinese stocks (which has been accompanied by selling in Southeast Asia) is partly driven by improving economic data and has sent the H-share index 13.2% higher since its most recent low point on August 7. The index, which tracks Chinese-incorporated companies listed in Hong Kong, is still down 6.4% year-to-date, but has outperformed most other regional indices in the past month.

By comparison, the Hang Seng Index has gained 6.4% since August 7 and Japan’s Nikkei 225 is up 4.3%, while the benchmark indices in Singapore and Indonesia have fallen 3.3% and 6.1% respectively.

Huishan Dairy is hoping to attract investors with its integrated business model that the company says allows it to “exert complete control over the entire dairy industry value chain”. According to a preliminary listing document, it is the most vertically integrated dairy company in China and self-sufficient both with regard to animal feed and raw milk. However, it does import heifers (cows that have not yet given birth) from Australia, New Zealand and Argentina, and frozen semen and alfalfa seeds from Canada and the US.

Aside from helping it to achieve higher profitability through an optimal cost structure, Huishan Dairy says the vertical integration “from grass to glass” ensures the quality and safety of its products – a key issue in the Chinese diary industry that has been plagued by a number of scandals in the past few years.

In 2008, six Chinese infants died and tens of thousands fell ill after drinking domestically-produced milk powder contaminated by melamine. The scandal triggered wide-spread scepticism about the quality of milk produced in mainland China and resulted in a boost for imported products. It also became the starting point for a consolidation of the domestic dairy industry.

And then in early August this year, New Zealand’s largest exporter of milk powder, Fonterra Cooperative Group, recalled whey powder concentrates (used to make infant formula) that had been sold to China amid fears that they may have contained bacteria that can cause a rare illness called botulism. Following the recall, China suspended all imports of whey powder concentrates from New Zealand and Australia. The New Zealand government later said that independent testing had shown that the powder in question contained no bacteria.

In the same month, five international producers of infant formula and one domestic importer were fined a combined Rmb670 million ($110 million) by China’s National Development and Reform Commission (NDRC) for anti-trust violations related to product prices.

Huishan Dairy, which started operations through its predecessor Liaoning Holdings only in January 2009 and hence was not involved in the 2008 melamine scandal, said in the preliminary listing document that the more recent issues “may result in a decrease in Chinese consumers’ reliance on imported products and therefore benefit reputable domestic producers of infant milk formula power.”

Milk powder is still a relatively small product for Huishan Dairy, however, as it began commercial production only in January this year. In the fiscal year to March 2013, milk powder products accounted for 3.4% of the total revenue after eliminating the raw milk used in its own business. Raw milk sold to outside customers accounted for 26.7% and liquid milk products, including fresh milk, UHT milk and yogurt, made up 66.9%. The rest came from grain processing and trading, a business that has since been discontinued.

The company grows alfalfa and supplementary feeds on an area the size of Hong Kong or Manhattan that it uses to feed its more than 112,800 dairy cows. The raw milk that it gets from these cows is then used to produce liquid milk and milk powder. As of March 2013, it had an annual production capacity of 90,000 tonnes of liquid milk products and 26,000 tonnes of milk powders. It is also able to produce 12,000 tonnes of D90 whey powder.

It sells its products to both industrial and retail customers, primarily in China.

Deal terms
The deal comprises approximately 3.79 billion shares, or 26.3% of the enlarged share capital. The shares are offered at a price between HK$2.28 and HK$2.67 apiece, which translates into 14.5 to 17 times forecast earnings for the fiscal year to March 2014, based on the bookrunner consensus.

The company has grown rapidly since it was started less than five years ago and in the 12 months to March 2013 it posted a 91.5% increase in revenues to Rmb2.55 billion ($413 million) from a year earlier. Net profit before biological fair value adjustments improved by 163% to Rmb1.01 billion in the same period.

The valuation puts it at a discount to Hong Kong-listed China Mengniu Diary, which is larger in terms of sales volumes and market capitalisation but does not have the same vertical integration. Mengniu, which is in the process of acquiring its Hong Kong-listed rival Yashili International, is currently quoted at price-to-earnings multiple of 22.8 for the 2014 calendar year.

China Modern Dairy, which is also listed in Hong Kong, trades at 17.8 times its projected earnings for the fiscal year to June 2014, according to Bloomberg data.

Chinese dairy companies that are listed in Shanghai trade for the most part at forward P/E ratios in the 20s, one source said.

The deal comes with the usual 90-10 split between the institutional and retail tranches and standard clawback triggers. About 76.9% of the base deal is made up of new shares, while the rest are secondary shares that will be sold by a number of existing investors including chairman Yang Kai.

There is a 15% overallotment option of all secondary shares that will increase the deal size to 30.3% of the company and the total proceeds to as much as $1.5 billion, if fully exercised.

The largest of the three cornerstones is the investment arm of Norges Bank, the Norwegian central bank, which manages the country’s oil revenues and has agreed to take up 360.2 million shares, or about $106 million at the bottom of the price range. It is joined by Inner Mongolia Yili Industrial Group, a customer of Huishan Dairy’s that has agreed to invest $50 million, and Bao Hua, the private equity arm of state-owned food-industry group Cofco, which will take up $40 million worth of shares.

Huishan Dairy also has the backing of New World Development chairman Cheng Yu Tung, who bought part of a $290 million exchangeable bond (EB) issued by the company in June 2011. The EB will be exchanged into shares in connection with the IPO, leaving the bond holders, which also include Investec, with a combined 19.65% stake in the company. Cheng Yu Tung will sell some of his shares through the IPO, however.

The institutional offering will remain open until September 18 and the price will be determined the following morning. The trading debut is scheduled for September 27.

Deutsche Bank , Goldman Sachs, HSBC and UBS are joint global coordinators and bookrunners for the IPO. CIMB, Investec and Jefferies join them as bookrunners.

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