Nine Dragons Paper wraps up IPO

Institutional orders capped at $20 million each as retail investors walk off with half the deal.
Nine Dragons Paper has priced its initial public offering right at the top end of the price range at HK$3.40 per share after strong demand from both institutional and retail investors.

That price has enabled ChinaÆs largest container board manufacturer to raise HK$3.40 billion ($438 million), which makes the BNP Paribas Peregrine and Merrill Lynch-led offering the largest IPO in the Hong Kong market since Link ReitÆs $2.5 billion offering in late November.

If the 15% greenshoe is exercised in full, the total proceeds will increase to $504 million. Nine Dragons offered one billion new shares, or 25% of the company.

The institutional portion of the offer was said to have been more than 30 times covered when the books closed last Thursday, with about 40% going to Asia and the rest split evenly between investors from Europe and the US. The oversubscription rate referred to the 36% of the offer that was available to institutional investors after the retail tranche was increased to 50% and about 14% of the deal were reserved for three corporate investors, which agreed to buy a combined $60 million worth of shares in the offering.

The size of the institutional book tells only part of the story, however, as investors were told to limit their orders to a maximum of $20 million each.

The decision to cap the orders was taken early on in the bookbuilding process amid expectations - which were later to prove correct - that local retail investors would ask for more than 100 times the amount of shares earmarked for them and therefore trigger an automatic clawback, that would boost the size of the retail tranche to 50% of the total offer from the original 10%.

The retail portion of the offer eventually ended up being about 520 times covered, freezing up HK$600 billion worth of local cash. The strong post-listing performance of several Hong Kong IPOs over the past three months is expected to have contributed to the overwhelming response.

BNP for one, would have been tempted to highlight the performance of two other mid-sized companies it has taken public over the past three months, namely mainland department store operator Parkson Retail, which has soared 96% since its debut on November 30, and Xiamen Port, which is up 54% since started trading in mid-December.

The price values Nine Dragons at 13.6 times its projected 2006 earnings, which according to the prospectus will be at least Rmb1.05 billion, or Rmb0.26 per share (HK$0.25 per share).

This is in line with Hong Kong-listed rival Lee & Man Paper, which trade at a 2006 P/E ratio of about 14 times after a strong run that has seen its share price more than double to HK$10.60 from its September 2003 IPO price of HK$4.17. The stock rallied 12% last week as Nine Dragons IPO attracted attention to the sector.

And analysts expect an upward price curve for Nine Dragons too.

ôThe strong demand (for the IPO) and the good growth prospects for ChinaÆs paper industry should enable the share price to trade at a forward P/E of 18-20 times,ö one analyst comments.

Investors were said to have accepted a lack of an IPO discount as Nine Dragons is almost twice the size of Lee & Man with 10 machines at two production sites in Dongguan and Taicang, just outside of Shanghai. Nine Dragons also has a more aggressive expansion plan in mind with the addition of three more paper machines by 2007 and at least one more in 2008. This will boost its total annual capacity to 5.4 million tons from 3.3 million tons today.

By comparison, Lee & Man will boost its capacity by 25% to 2 million tons in the first quarter of 2007 when its eighth paper machine will begin operations and will add another 300,000 tones of capacity in the second half of that same year when a new plant in Chongqing will be ready.

The listing candidate, which began operations in 1998, has also shown steady growth in the past three years with revenues increasing 46.6% per year and profits up 65.7% a year. This has been supported by a compound annual growth rate of 67.3% in production capacity and 39.8% in sales volumes.

The company mainly produces high-performance corrugated board, coated duplex board and liner board, which are used as packaging material û a commodity in huge demand in ChinaÆs rapidly growing manufacturing industry. ChinaÆs container board producers are currently only able to meet about 90% of the countryÆs demand and the increased capacity will put Nine Dragons, which already has a market share of about 16%, in a strong position to fill in some of that gap, analysts say.

Investors also overcame concerns about a series of connected transactions with parties linked to Nine DragonÆs controlling shareholders and the fact that the listing candidate sources more than 80% of its raw materials from America Chung Nam, which is wholly-owned by these same shareholders.

In the prospectus, the company devoted 17 pages to explain why these relationships should not be a concern and also stressed that Cheung Yan and her husband Liu Ming Chung, who are the controlling shareholders of Nine Dragons, both resigned as directors of ACN in January and have no role in the day-to-day business of that company. The pair are still the sole owners of ACN, however, which was set up by Cheung in 1990 as a US-based collector and trader of old corrugated cardboard (OCC) - a key raw material for the production of container board.

Ms Cheung is also the founder of Nine Dragons and acts as the companyÆs chairman, while Mr Liu is deputy chairman and CEO.

ôAs long as these transactions are conducted at arms length, which the company has done, then they shouldnÆt be a problem,ö one observer notes. ôThis is a high quality company û a blue-chip of tomorrow.ö

During the roadshow, it also emerged that Nine DragonsÆ only non-executive director happens to be the 24-year-old son of Ms Cheung and Mr Liu, who is currently studying at The University of California. The company also has four independent non-executive directors on its nine-person board.

While this was clearly seen as a problem, many investors still believe questionable corporate governance practices is something that has to be accepted when investing into up-and-coming Chinese companies.

ôEvery company we look at in China has corporate governance issues, thatÆs just the way it is,ö says one banker not connected with the Nine Dragons IPO. ôInvestors donÆt like it and would rather see these things cleared up before listing, but they will still buy in while voicing their concerns and saying that they want the company to change.ö

According to the prospectus, Kuok Hock Nien, who also controls Kerry Properties, Shangri-La Asia and the SCMP Group, New World Development Chairman Cheng Yu-Tung and Henderson Land Development Chairman Lee Shau Kee, each agreed to subscribe to $20 million worth of shares in the IPO. The three tycoon bought the shares through private investment companies. They will be subject to a six month lockup.

Nine Dragons will start trading on Hong KongÆs main board on March 3.

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