Sinopharm sets price range for $1.13 billion IPO

The Chinese distributor of pharmaceutical products will be the first company to take orders for a Hong Kong listing after the summer and has set the price range at HK12.25 to HK$16 per share.

Sinopharm, the largest distributor of pharmaceutical products in China, will be the first company to start accepting orders for a Hong Kong initial public offering when it kicks off its roadshow today. It is getting a head start on the five companies that are currently engaged in investor education and several others that are expected to follow in the weeks ahead.

The state-owned company will seek to raise between HK$6.68 billion and HK$8.73 billion ($862 million to $1.13 billion) after sources said it has set the price range at HK$12.25 to HK$16 per share. This will make it the second largest Hong Kong IPO this year after aluminium extrusion company China Zhongwang Holdings, which raised $1.26 billion in early May, and ahead of cement producer BBMG, which raised $768 million in a highly sought after deal in July.

However, Sinopharm is unlikely to keep that spot for long as Metallurgical Corporation of China (MCC) will be snapping at its heels with an H-share IPO of about $2.3 billion that will go on the road on Monday. MCC, which is the largest engineering and construction (E&C) company in the world and also involved in manufacturing, resources, and property development, is pursuing a dual listing in Hong Kong and Shanghai and, if successful, will start trading in Hong Kong the day after Sinopharm.

Sources say there has been good response for Sinopharm's offering so far and one banker projected that the deal will be a few times covered after the first day of order-taking. The fact that the company has signed up nine cornerstone investors has helped attract attention to the deal, and may also add momentum to the order flow early on. The cornerstones, which include mainland companies China Life Insurance, Bank of China Group Investments and CCB International, and Hong Kong banking tycoon David Li, have committed to buy a combined $195 million worth of shares which, depending on the final price, will account for between 17% and 23% of the total deal before the exercise of the 15% greenshoe.

Investors say they are interested in the deal because of Sinopharm's strong market position as the dominant and only nationwide player in an industry that is expected to see significant growth in the years ahead. But valuation will clearly also be important, especially since global equity markets have shown signs of stalling this week. A 1.2% gain in Hong Kong's Hang Seng Index yesterday and a strong finish to US trading overnight -- the Dow Jones index climbed from flat to a gain of a 0.7% in the final hour of trading -- should provide a relatively good backdrop for Sinopharm's first day of bookbuilding though. Also, bankers have earlier said that they believe investors will be more keen to participate in IPOs at a discount than to buy shares in the secondary market while the near-term direction of the market remains somewhat uncertain.

The price range translates into a valuation of 19.5 to 25.5 times the company's projected 2010 earnings, based on the syndicate consensus. There are no direct comparables, in the international markets - basically Sinopharm is growing at a much faster pace than similar companies in the US and Hong Kong-listed Guangzhou Pharmaceutical is a much smaller company with a market cap of just $850 million.

As a result, the China-listed pharmaceutical distributors are likely to be used as the key benchmark, even though A-shares tend to trade at a significant premium to their H-share comparables. According to a source earlier this week, the Chinese distributors trade at an average 2010 price-to-earnings ratio of 28 times.

Sinopharm posted a net profit of Rmb585 million ($86 million) in 2008 after growing at a compound annual growth rate of 140% in the 2006-2008 period. And analysts project the high growth to continue. In 2009 the bottom line is expected to be Rmb842 million, representing about 43% growth, and similar 40% growth rates are envisioned for the next few years.

Sinopharm is offering 545.679 million new H-shares, which represent 25% of the company. As usual, 10% of the shares on offer will initially be set aside for Hong Kong retail investors, but in case of a clawback, Sinopharm has obtained a waiver that will allow it to limit the retail portion to a maximum 35% of the deal, as opposed to the normal 50%. This should make the deal slightly more attractive to institutional investors as they should be able to get a greater allocation.

If the retail tranche is between 10 and 35 times covered, the retail portion of the deal will increase to 20%; between 35 and 50 times covered, it will increase to 30%; and if retail investors subscribe to 50 times more shares than initially earmarked for them, the retail portion will be 35%.

Sinopharm is the largest distributor of pharmaceutical products in China with a market share of about 11% -- more than double the market share of the number-two player. Other selling arguments include a combination of scale, high growth and increased healthcare spending in China. The industry is also expected to consolidate along the lines of what has already been happening in Europe and the US. And except for one much smaller player, there are no Chinese pharmaceutical distributors listed in Hong Kong, making Sinopharm something of a novelty.

Analysts note that healthcare spending account for only 4.5% of GDP in China, compared with 75% in the UK and more than 90% in the US, suggesting a lot of room for growth. Also, with regard to consolidation, the top three pharmaceutical distributors in China have a combined market share of only 20%, compared with a 64% market share for the top three players in Europe and 90% for the top three in the US.

The company is being brought to market by CICC, Morgan Stanley and UBS and is scheduled to start trading on September 23. The Hong Kong retail offering will run between September 10 and 15. The final price will be determined after the close of US trading on the 15th.

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