Pre-marketing for China Oilfield Services begins

Credit Suisse First Boston and Merrill Lynch launch a $250 million to $350 million IPO for CNOOC group company, China Oilfield Services Ltd.

At a time when the primary markets have been able to offer little but defensive equity plays with high dividend yields, joint bookrunners CSFB and Merrill are attempting to sell a growth stock tied to the development of China's offshore oil reserves.

Two weeks of pre-marketing and a further two weeks of roadshows will see a deal for China Oilfield Services price in mid-November representing up to 35% of the company's issued share capital (ex shoe). Potentially raising $350 million, the transaction has the usual 90%/10% split between institutional and retail investors and standard 91%/9% split of new and old shares. Co-leads are BOCI, CLSA, ICEA and UBS Warburg.

All concerned will be hoping the deal can ride on the back of CNOOC, which is up 41.5% year-to-date and has significantly outperformed the depressed Hang Seng Index, down 15.9%. One of the syndicate's chief jobs, however, will be to differentiate between the two companies.

CNOOC, a red chip, is widely considered to be one of the world's purest oil plays. But, the exploration and production company's $1.26 billion IPO (pre shoe) in February 2001 had to be priced relatively cheaply on an EV/EBITDA ratio of 3.5 times earnings in a reflection of one failed flotation and a reappearance of the China risk premium.

This time round, geography is being viewed as a positive for H-share China Oilfield Services, a fully integrated operator that does most of CNOOC's grunt work - setting up the rigs, drilling for oil and maintaining the wells, in addition to providing supplementary shipping services and some seismic services.

The company is primarily being valued in terms of EV/EBITDA and at the cheap end of the range, observers say it will pitched at a slight discount to CNOOC, which is currently trading on a 2003 EV/EBITDA of 5.4 times. In secondary market trading, however, it is expected to trade at a premium to CNOOC in line with the sector's global performance relative to E&P companies.

Specialists say the indicative range is likely to fall between five and 6.5 times, placing China Oilfield at a discount to global comparables such as Baker Hughes and Schlumberger from the US. Baker Hughes, for example, is currently trading on a 2003 EV/EBITDA ratio of eight times, while the sector average stands at 7.6 times.

Experts say that oilfield services companies historically trade at their highest multiples when oil prices peak and at their lowest multiples mid cycle. This is because E&P companies commit capital for expansion at the height of the cycle. Therefore, given that oil prices have now risen to $30 a barrel, up 50% year-to-date, this might imply the cycle is peaking.

However, both Baker Hughes and Schlumberger have traded down so far this year (14.16% and 18.78% respectively) and recently reported disappointing results. Industry experts consequently argue that the current cycle is not typical and further, that China Oilfield should be less cyclical than its peers since its growth is tied to China's huge undeveloped offshore reserves.

The oil service majors have also said that the current uncertain economic climate has led many of their clients (E&P companies) to use high oil prices to deleverage their balance sheets rather than expand production. Low demand for natural gas from the Gulf of Mexico, where they predominantly operate, has also been blamed for a drop in revenue. And all of the above means that in terms of the industry's main performance barometer - rigs in operation - the figure has dropped.

In selling China Oilfield, on the other hand, syndicate bankers are likely to place heavy emphasis on the development potential of China's offshore oil reserves. Unlike Petrochina and Sinopec, which were both cost restructuring stories, China Oilfield will be pitched as a company driven by bottom line growth similar to CNOOC before it.

And the statistics speak for themselves. Whereas the Gulf of Mexio has roughly 700 square kilometres being drilled and 14,000 wells in operation, offshore China has a drilling area twice the size, but only a fraction the number of rigs in operation - 700.

In making the case that China Oilfield is not a purely cyclical stock geared to oil prices, bankers are also likely to underline China's GDP growth rates (8%), its continuing status as a net importer of oil and the country's level of undeveloped reserves 60%.

This means that China Oilfield's net income has been growing and is forecast to continue growing at 22% to 25% per annum ($95 million end 2001). EBITDA margins are also increasing by up to 30% a year according to some analysts, who say that drilling in the South China Sea is more cost efficient as the waters are shallower and labour cheaper.

In terms of FY 2001 revenue breakdowns, the company received 42% from its drilling operations, 25% from well maintenance, 20% from marine services and 13% from its geophysical operations. It has 50% to 95% market share across its different business lines, with drilling recording the highest ratio and marine services the lowest. CNOOC is currently its major customer, but China Oilfield derives nearly 40% off its revenue from other operators in the South China Sea including Chevron and Texaco.

Observers also point out that China Oilfield has been able to maintain its market dominance despite 18 years of market liberalisation. "The one area where it might be easy to assume overseas operators would dominate is seismic services, because this is quite a technical field," says one specialist. "But China Oilfield has a huge competitive advantage because it has 20 years experience mapping out the whole South China Sea. It has also cleverly limited competition by tying up potential competitors through joint ventures."

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