Ozner turns on the IPO tap

Demand gushes for the Chinese water purification group's Hong Kong listing as retail books open.

The retail book for a $122 million to $147 million initial public offering of shares by Ozner Water, one of China's largest water purification suppliers, opened on Thursday.

Allocations are expected to be scaled back both for the institutional and retail tranche given the underlying appeal of the company, which is the first of its kind to list on the Hong Kong Stock Exchange.

Fund managers say the small offering size and attractive valuation, combined with the overall appeal of the water sector, are the key drivers behind strong demand. 

The group is offering 25% of its enlarged share capital pre-greenshoe, via a 442 million-share base deal, which is being marketed at between HK$2.25 and HK$2.7 per share.

There is the standard 90%/10% split between institutional and retail investors, although a $40 million chunk of the institutional segment has already been taken by cornerstone investor Och-Ziff Capital Management. Pricing is scheduled for June 11. 

Led by Goldman Sachs and Standard Chartered, the deal is being marketed on an estimated 2014 post money p/e range of 15 to 18 times. This places it at a substantial discount to the company touted as its nearest comparable, South Korea's Coway.

Coway currently has a market capitalization of $6.5 billion, roughly ten times larger than Ozner and is trading at 22.3 times forward earnings. Year-to-date, the stock is up 28%. 

Chinese comparables

There are a number of listed water companies in China but they tend to be in the water treatment business and are less of a consumer play than Ozner. Two comparables being looked at by fund managers include Beijing Originwater Technology and Shanghai Canature Environmental Company.

Shares in Beijing Originwater are currently trading at 24.15 times 2014 earnings and have lost about 20% so far this year, while Shanghai Canature is trading on a price-earnings ratio of 40.29 times and its share price has risen 18.3% year-to-date.

Ozner's two biggest domestic competitors are white goods company Midea and Qinyuan. All three operate in a very fragmented market, with Midea holding a 2.2% market share, Qinyuan holding 1.6% and Ozner 1.1%. 

Midea is an outlier in terms of valuation, trading at 7.8 times forward earnings. The group recently signed an agreement with Alibaba to develop smart household devices supported by cloud computing.

Unlisted Qinyuan is also likely to provide Ozner with significant competition in the future following its acquisition in March by Unilever, the UK consumer group's biggest Chinese deal in a decade.

Rich valuations

Water has been a popular Chinese sector with investors in recent years but many wonder whether valuations have already priced in considerable future upside and become expensive. 

During the Hong Kong roadshow, Ozner executives argued that the industry in China is still in the early stages of high growth and that it has the potential to grow in value to Rmb 125 billion ($20 billion) by 2017 from Rmb 54.4 billion in 2013.

They also estimated that the use of water purifiers will jump to 32% of residential users and 27.7% of commercial users by 2017 from 6.8% and 12.2%, respectively, last year, driven by well-documented fears about the safety of China's water supply. 

Due to chronic Chinese pollution about 60% of the country's ground water and 40% of its lake water is unsuitable for human consumption. Consumers also shun drinking tap water even when it has been boiled because of residual chemicals, metal ions and microorganisms that might have bred in ageing pipes.

As a result, Ozner, which was founded in 2010, has been on a strong growth trajectory. Revenue increased from Rmb 102 million to Rmb 402 million between 2011 and 2013, while net profit margins have expanded to 38% from 22.4% over the same time period.

During the roadshow, Ozner attributed this performance to a growing contribution from water purifiers, which has jumped from 43.9% of total revenues in 2011 to 78% in 2013. 

Proceeds from the IPO are being used to propel the group's four-pronged strategy. This includes expanding its distribution network into China's third- and fourth-tier cities, doubling its production capacity by building a new facility (scheduled to come online this August), investing in technology and in sales and marketing. To date, executives say they have relied on word of mouth.

Founder Shu Xiao will remain the company's biggest shareholder after the IPO (but before any greenshoe) with a 26.4% stake. Three private equity investors will also retain considerable stakes, with SAIF Partners on 19.84%, Ares on 13.86% and Goldman Sachs on 8.24%. 

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