Small-cap Chinese chemical company seeks US listing

Chemspec and pre-IPO investors aim to raise a combined $73 million from an offering that closes this week.

While the US stockmarket appears to have run out of steam over the past three weeks after rallying 34% since early March, Chemspec International will be hoping that some of the investor cash that is arguably still waiting to be put back into equities will find its way into its initial public offering this week. The company is aiming to raise between $56.6 million and $72.8 million, although approximately 22% of that will go to a group of existing investors who will be selling a portion of their holdings as part of the IPO.

Aside from the fact that the offering comes with the customary IPO discount -- giving investors the potential for a quick pick-up in the value of their holdings -- the deal is also riding on the back of an extremely strong performance of the most recent Chinese company to list in the US. As of Friday, online gaming company had risen 140% since its listing on April 2, so even if Chemspec does only half as well, it would make it worthwhile for investors. However, compared to Changyou, Chemspec operates in an industry that is significantly less well-known and it also doesn't have the benefit of being spun-off from a parent company that investors are already familiar with. Chemspec is also a small-cap stock -- it will have a market capitalisation of no more than $327 million at the time of listing -- which is bound to keep many investors away amid concerns about after-market liquidity.

Sources say the investors most likely to participate in the offering are funds specialising in either small-caps or China, and potentially a few dedicated to the chemical sector, which have put in the work to understand the business. That in mind, joint bookrunners Citi and Credit Suisse spent two weeks on investor education before the management roadshow kicked off on June 11. The deal is due to close at the end of US trading tomorrow and the shares will debut on the New York Stock Exchange on June 24, becoming only the second Chinese company to list in the US this year.

According to its listing prospectus, Chemspec is a leading Chinese contract manufacturer of highly engineered fluorinated specialty chemicals used mainly for the production of electronics, pharmaceuticals and agrochemicals. Most of its products are customised and, as a result, it has a loyal customer base with its top 10 customers in 2006 all returning to place orders for existing or new products in 2007. Nine of its top 10 customers in 2007 returned in 2008.

Revenues expanded at a compound annual growth rate of 60% between 2004 and 2008, reaching Rmb944.9 million ($138.3 million) last year, and according to Frost & Sullivan, the company had a 25% share of the Chinese market in terms of sales. And the top-line has the potential to continue to grow as Chemspec is in the process of increasing its maximum production capacity to 2.8 million litres of reactor volume by the end of 2009 through the opening of new production facilities as well as the expansion of its existing ones. As of the first quarter this year, the company had four production facilities and a maximum production capacity of 1.1 million litres of reactor volume.

According to the prospectus Chemspec intends to use about $40 million of the $43.7 million in net proceeds that it will receive if the deal is priced at the mid-point to fund the expansion of its manufacturing capacity.

It is also in the process of building a new research and development centre in Shanghai that can support up to 350 scientists and is expected to be completed in the second half of the this year. Chemspec currently employs 91 research scientists and technicians.

The Shanghai-based company, which was founded in 1996, is offering 22.3% of its enlarged share capital in the form of 8.087 million American depositary receipts, each of which represent 60 ordinary shares. The ADRs are marketed at a price between $7 and $9 apiece, which sources say translates into a price-to-earnings multiple of 6.7 to 8.6 times its 2009 earnings, based on projections by the joint bookrunners.

While there are no other listed companies with the same scope of business as Chemspec, some investors have been looking at China's Wuxi PharmaTech, which is also listed in the US and has some businesses that overlap with what Chemspec is doing, for some guidance on valuation. Wuxi is, however, primarily a contract research company. It currently trades at about 13 times this year's earnings.

The majority of the offering -- 78.2% or 6.328 million ADRs -- is backed by new shares, while the remainder will be sold by pre-IPO investors, including David Tang, the company's executive vice-president of marketing and research & development, and his family.

The deal also includes a 15% overallotment option that could increase the maximum deal size to $83.7 million. All the ADRs sold as part of the overallotment option will be backed by secondary shares coming from members of the management as well as three investors who will receive shares in Chemspec in connection with the IPO by converting various loans and notes that they have provided to/bought from the company's chairman in recent years.

Except for the ADRs sold under the overallotment option, all existing shareholders will be locked up for six months.

Revenues may have grown strongly in recent years, but the company is not without challenges. For one, a large part of its business is cyclical and its sales of specialty chemicals used to make thin-film transistor liquid crystal displays (TFT-LCDs) and other electronics, which accounted for 55% of revenues in 2008, suffered in the first quarter this year as that industry saw a significant slowdown.

While the company is projecting a more positive outlook for electronics in the third and fourth quarters, going forward it also plans to put more focus on higher value-added specialty chemicals for the pharmaceutical and agrochemicals (mainly fertilisers) industries, which last year accounted for 30% and 15% of sales respectively. It says it believes it is "well positioned to take advantage of increasing market demand for outsourcing of the design and manufacturing of more complex and highly engineered specialty chemicals, including both fluorinated and other types of specialty chemicals." 

Also in the market seeking a US listing at the moment is Duoyuan Global Water, a China-based supplier of equipment for water treatment, including purification and waste water treatment. The company is tapping into expectations that the urbanisation and industrialisation in China, which is leading to severe water shortages and the pollution of natural water resources, will continue to drive demand for water treatment equipment for the foreseeable future. According to market research firm the Freedonia Group, the demand for water treatment products in China is estimated to increase by about 15% per year through 2012.

Roughly the same size as Chemspec, Duoyuan is aiming to raise up to $65 million with the help of sole bookrunner Piper Jaffray. According to US media, this deal is also expected to price this week.

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