Steel billet maker China Oriental secured a HK$1.93 billion ($248 million) IPO at the very top end of its indicative range yesterday (Tuesday). With JPMorgan and Merrill Lynch as joint bookrunners, a 700 million share offering was priced at HK$2.75 per share after being marketed on a wide range spanning HK$2.10 to HK$2.75.
At this level the IPO was priced on a syndicate 2004 P/E ratio of 6.1 times. This in turn represented an approximately 25% discount to the 8.3 times P/E average of the big three Chinese steel manufacturers listed on the Hong Kong Stock Exchange - Maanshan Iron & Steel, New Angang Steel and Chongqing Iron & Steel.
From the outset, institutional orders were capped at $20 million per account, but the book nevertheless went on to close 16 times covered with participation by 350 investors. By geography, the deal had a spit of 37% Asia, 33% US and 30% Europe. By investor type, global funds accounted for 37%, China funds 31%, global emerging market funds 18% and steel funds 14%.
On the retail side, books closed 704 times covered, prompting the full clawback to 50%. Citic and Cazenove were also co-leads.
When the two leads started pre-marketing the deal at the end of January, the market for Chinese cyclical stocks was not quite so hot as it is now and many counters were facing a correction. Angang New Steel, for example, had come off from a high of HK$4.50 per share at the beginning of the month to trade around the HK$3.50 mark by the end of it.
Investors were concerned that steel prices were peaking and valuations had overshot themselves on the back of the extraordinary liquidity, which had come pouring into the Hong Kong stock market during the fourth quarter of 2003. As a result, the leads decided to go out with a wide pre-marketing range in the hope of drawing investors in at the bottom, building momentum, then pricing towards the top.
The original pre-marketing range spanned a 2004 P/E range of 4.9 to 7.3 times and 2004 EV/EBITDA range of 4.4 to 6.5 times. Final pricing at respectively 6.1 times and 5.5 times came in at just above the mid-point of both.
Specialists say this valuation point encompasses any risk that steel prices may soften.
"It's really not a great idea to push a cyclical stock like this too far," says one. "But its success just goes to show how much liquidity is still flooding through the market. The only way accounts can get hold of enough stock to put money to work is through the primary market."
Comparable stocks such as Angang also started strengthening again after Chinese New Year. During February the stock has shot back up from HK$3.50 to close yesterday just off its 12-month high at HK$4.475.
With China Oriental, one of investors' chief concerns was how the company will be able to maintain 27% plus EBITDA margins. Management says it is moving into higher margin products and will continue to cut costs.
Currently its principal products are steel billets and strips. Billets are one of the first steel products produced from iron in the steel manufacturing chain. At the end of 2003, the company was producing 3.1 million tonnes of billets, of which about 2.4 million tonnes were available for sale to other downstream steel manufacturers.
The company was running at a high utilization rate of 94% and ranked as one of the lowest cost producers with an RMB1,310 average per tonne of steel compared to RMB1,624 for 17 other Chinese steel producers (2001 figures).
Future investment plans are for a steel rolling line to produce higher margin mid-width strips and a second to produce H-section steel, which is used in the construction industry. The former is expected to have a production capacity of 800,000 tonnes, starting from the second quarter and the latter one million tonnes.
The company's IPO is also unusual in that it marks the first former State Owned Enterprise to successfully MBO and list overseas. Since its transformation into a sino-foreign JV in 2001, the company has seen volume grow by a CAGR of 56%.
The offering represents 25% of enlarged share capital.