Recycling company targets Hong Kong listing

Hong Kong's latest listing candidate doesn't mind being left with the scrap. In fact, it buys it from as far away as Europe and the US. China Metal Recycling (CMR) is China's largest scrap metal recycling company in terms of revenue and the first one in its industry to seek a listing in Hong Kong. UBS is arranging the initial public offering of up to $200 million.

CMR buys scrap steel, scrap copper and other scrap metal and uses heavy machinery and manual labour to separate it into its various metal components. From that it produces scrap metal products of varying purity and sizes that it then sells on to manufacturers of that respective metal for further processing into new metal products.

The company is benefitting not only from the growing interest in the "clean and green" theme, but also from the significant growth in the consumption of both steel and copper in China over the past few years. With regards to steel, there has also been a trend towards using electric arc furnaces in the production process as they are more efficient than the traditional blast furnaces in the sense that they use approximately 60% less energy and 40% less water and produce 97% less waste, according to data from the China Association of Metal Scrap Utilisation. The electric arc furnace process uses recycled scrap steel as its primary raw material (blast furnaces use primarily iron ore) and in 2005 the Chinese government adopted a new steel policy that aims to increase the use of scrap metal in the production of steel.

With regards to copper, recycling is becoming increasingly important due to the short supply of copper resources and high exploration costs due to small-scale mines and low-grade ore. The company thus expects demand for secondary copper, which are concentrates produced from scrap copper, to strengthen over time in China. Between 2004 and 2007, the demand for copper and other non-ferrous metals in China grew at a compound annual growth rate of 20.4%, while the demand for steel grew at a CAGR of 13.9% in the period between 2003 and 2007.

While scrap metal recycling is a very asset-light industry, it is also a business that requires a lot of working capital -- something that CMR is hoping will be easier to come by as a listed company. Initially it is looking to raise between HK$1.19 billion and HK$1.55 billion ($154 million to $200 million) by floating 30% of the company. The institutional roadshow kicked off yesterday and will be followed by the opening of the Hong Kong public offering on Wednesday, with the entire offering due to close by June 16 and the trading debut scheduled for June 22. The timetable is tight compared with the typical two-week marketing period for a Hong Kong listing, but people close to the offering say the management and the bookrunners wanted to reduce the risk of a potential set-back in the equity markets during the offering period as much as possible. The size of the deal is small enough that this shouldn't be a problem and much of the groundwork has in any case been laid during the previous two weeks of investor education.

According to a source, several investors have already indicated their intention to put in "chunky" orders, although there were no anchor orders per se when the book opened.

CMR is offering 300 million new shares with an option to sell an additional 15% if there is enough demand. The price range has been set at HK$3.98 to HK$5.18. There will be the usual split with 90% going to institutional investors and 10% set aside for retail investors, although normal clawback triggers apply and could increase the retail tranche to as much as 50% in case of strong demand. However, retail investors may be less excited than institutions by the fact that CMR represents a new industry that can be added to a portfolio focused on China or small-caps.

The price range values the company at 9.6 to 12.5 times its 2009 earnings, which according to syndicate research is expected to end up at around HK$415 million -- an increase of about 41% from 2008. Looking ahead to 2010, the price-to-earnings ratio drops to 4.8 to 6.3 times. The company told investors who attended its luncheon in Hong Kong yesterday that the profit projection for the six months to June is only HK$68 million, but this is due to high interest payments on an outstanding senior note that will be paid off the day after the IPO. If the interest cost is added back in, the net profit would be HK$184 million, a company official said.

According to the preliminary prospectus, CMR will use about 60% of the net IPO proceeds to pay off the notes that were bought in 2007 by UBS and two hedge fund managers -- Spinnaker and ADM. The notes carry a high coupon of 8.5% and are also highly restrictive in terms of how much other borrowings the company can take on. CMR told investors yesterday that it has already lined up other loan possibilities in the domestic bank market, which will not only be cheaper but will also come with a tax benefit.

Under the terms of the notes, the company has to pay interest to the noteholders until October 23 even though the notes will be redeemed the day after listing. The notes also come with a number of warrants that the noteholders have agreed to settle for cash immediately after the listing, at an additional cost of about $17.4 million.

The remaining 40% of the proceeds will be spent on inventories, production facilities and equipment at its new and existing facilities. 

The company's existing recycling facilities are located in the Guangdong and Jiangsu provinces and in Hong Kong. It is also in the process of setting up a second facility in Jiangsu, as well as new facilities in the city of Tianjin and in the Zhejiang province, which are expected to be completed by the end of the third quarter this year and will almost double its annual production capacity to 3.1 million tonnes from 1.6 million at present. It also plans to open a new recycling facility in Hubei province in central China in 2010, which will increase the capacity to 3.6 million tonnes.

One of CMR's advantages, it says, is that its facilities are located in China's key metal producing regions where there is high demand for recycled scrap metal and they also have access to waterways which provide low-cost and efficient transportation for both raw materials and recycled scrap metal.

CMR has seen rapid growth since it was founded by its current chairman Chun Chi-wai and Lai Wun-yin, who is now a non-executive director, in 2000. Over the past three years, revenues have grown at a CAGR of close to 145%, reaching HK$6.5 billion in 2008. The improvement is primarily due to an increase in sales volumes of non-ferrous metals as well as an increase in the average sales price per metric tonne across the company's products. Net profit expanded from HK$46.6 million to HK$294.4 million in the same period.

Once the senior notes have been redeemed, the company will have no debt and about HK$1 billion of cash on hand.