Petrochina pumps up the war chest

Chinese oil company raises equity to fund country''s aggressive search for global oil assets.

Hong Kong and New York listed Petrochina raised HK$18.98 billion ($2.43 billion) yesterday (Wednesday) from the sale of a 3.164 billion share deal via Citigroup, Deutsche Bank and Goldman Sachs. The deal was priced at HK$6 per share and there is also a 351.65 million share greenshoe that could lift proceeds to HK$21.089 billion ($2.7 billion).

At this level, the offering came at a 4.8% discount to the stock's HK$6.3 close on Tuesday August 30 and a 6% discount to the ADR close later the same day. On an ex-dividend basis, it was priced at a 2.4% discount to the local close and a 3.8% discount to the ADR close. The dividend is scheduled to be paid on September 7.

Pricing came at the very tightest end of a 4.8% to 7.1% discount range in a reflection of a strong order book that closed 3.5 times covered at issue price with participation from roughly 350 investors.

This level of interest is hardly surprising given the twin attractions of the dividend and rising global oil prices. Where the former is concerned, Petrochina is currently trading on a 2005 yield of about 4.7% and typically pays out about 40% to 50% of net income.

In terms of global oil prices, industry experts tend to agree that the direction remains solidly upwards despite the fact that many also believe a barrel of crude should trade at no more than $50/bbl to $55/bbl on a fundamentals basis.

Says one former Chinese oil industry executive, "Personally I believe current prices above this level reflect a large amount of speculative froth in the market and there could be a very nasty shock if there's a sudden reversal of sentiment. We all hope oil prices are slowly managed back down to reasonable levels. However, it looks like they will continue to climb above $70/bbl in the near future."

Petrochina's deal incorporated 90.9% in new shares and 9.1% in old shares. Because liquidity is so high, the new deal is unlikely to weigh too heavily on the market and equates to only 26 days trading volume.

What it will do, however, is to increase the freefloat to a more reasonable level. Pre deal, CNPC owned 90%, with 8.66% in freefloat and 1.34% owned by Warren Buffett. Post deal (including the greenshoe) these ratios will change to 88.21% (CNPC), 10.47% (freefloat) and 1.31% (Warren Buffett unless he topped himself via the new deal).

In total the deal represents 20% of the existing issued share capital and will dilute 2005 EPS by about 0.6%.

But the key point is why Petrochina has chosen to raise so much new cash given the strength of its existing cash flows. Analysts estimate the company has free cash of just over $7 billion and its net gearing level is also very conservative, standing below 10%.

In a statement Petrochina said proceeds will be used for business development and to fund domestic or overseas acquisitions. Indeed, China's desire to secure key global oil assets to fuel its rapidly expanding economy has been one of the dominant themes of the year.

But while CNOOC recently failed in its $18.5 billion cash bid for Unocal, Petrochina's parent CNPC was able to secure PetroKazakhstan at the end of August for $4.18 billion. The most logical outcome is that proceeds from Petrochina's new equity deal will be partially used to fund the injection of this asset into a new company the two Chinese oil groups formed in June.

The uninspiringly titled company known as NewCo is a 50/50 joint venture between Petrochina and CNPC. It holds all of the two companies' overseas oil assets bar CNPC's oil fields in Sudan, which were excluded because the country is still under US sanctions.

NewCo is expected to be separately listed at some point within the next year and its major existing asset is a second oil field in Kazakhstan - AktobeNunaiGaz, which equates to just over 50% of NewCo's existing proven reserves. The central Asian country is increasingly becoming the lynchpin of China's global oil ambitions, with the latter clearly courting the former's 3.3% control of global oil reserves.

Analysts estimate that Kazakhstan will become the world's second largest oil supplier within the next two decades and China has already started to capitalise on this by building a 3,000km pipeline between the two countries. Phase one of the development is expected to be completed by the end of this year and is being jointly managed with the Kazakhstan government.

Analysts say that NewCo comprises 15 oil and gas assets in a dozen international countries, of which the majority (85%) are oil based. Most of the assets were injected by CNPC, with analysts valuing them at $3.48 billion plus $983 million in debt.

Petrochina also injected its one existing international asset - an Indonesian oil field, which has a valuation of $452 million plus $382 million in debt. In lieu of paying CNPC for the asset injection, Petrochina structured the deal via a $2.5 billion capital injection into the JV in order to give it a war chest for future acquisitions.

Around the time of its formation company officials said NewCo was examining the prospects of a further 10 new overseas projects. Analysts also say that the early stage nature of NewCo's assets provide a good balance to Petrochina's more mature domestic oil fields.

However, the huge size of Petrochina's domestic operations means NewCo will only account for about 4% of proven reserves. CSFB also estimates that it will add about 1% to 2% to net income over the coming year.

During the first half of the year, Petrochina maintained its status as Asia's most profitable company, reporting net income of Rmb61.6 billion ($7.62 billion), up 36% year-on-year. Most of this earnings growth came from the company's E&P operations, which account for 99% of its total EBIT.

In turn, a 61% increase in EBIT at its E&P operations was attributed to rising oil prices and a 5% increase in production growth. However, analysts have cautioned that the company's refining operations are acting as a drag despite their smaller size. The division reported a first half loss of Rmb13.3 billion largely thanks to China's price caps.

Petrochina also said that costs rose 46% year-on-year, with lifting costs up 15% to $5.1/boe.

At HK$6.30, Petrochina is currently trading at about nine times 2005 earnings. This puts it at the higher end of the scale for global oil companies and second only to Reliance Industries, which tops 9.5 times.

Year-to-date, the stock is up 51.81%. The company will now be subject to a six-month lock-up on further equity raisings.

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