Solomon Systech IPO defies gloom

Hong Kong''s first large fabless IC design company prices at HK$1.75.

Despite the end of Hong Kong's IPO bull market in March, the Territory's first large fabless IC design company managed to raise $135.3 million pre greenshoe Wednesday, after pricing its shares midway in the HK$1.60 to HK$2.05 range.

Led by JP Morgan, with CLSA and BNP Peregrine Paribas as co-leads, the company sold 603.58 million shares of which 56% were primary shares.

Both the retail and institutional books are believed to have closed twice covered. Allocations saw 11% go to Hong Kong retail, while 89% went to institutional investors. About 2% of the retail offering was also allocated to company employees.

If the standard 15% greenshoe (wholly composed of primary shares) is exercised, the amount will rise to $155.25 million. The pre-greenshoe free float amounts to 25% of the enlarged share capital.

"Demand was very comfortable," says one specialist. "The top five institutions could have taken the whole deal."

About 70 institutional investors participated in the deal, with seven institutional investors asking for 10% or more.

In terms of demand, the geographic split came out as 60% Asia, 30% Europe and just 10% from the US.

Valuation was always going to be a challenge, following the rough reception given to mass market mobile phone company China Resources People's Phone on Monday. That deal saw the lead underwriter left holding 8% of the deal, while other recent IPOs, notably foundry Semiconductor Manufacturing International and tom.com spin-off Tom Online, are trading below their issue price.

However, specialists point out that Solomon has very solid fundamentals and this helped it price at a slim discount to its comparables. Specialists say that while the company likes to compare itself to global IC design houses such as Epson, Hitachi or Samsung, their IC design units are often unlisted and inappropriate for comparison purposes.

"Therefore it's better to look at listed Taiwanese design houses such as Mediatech, Realtech and Novatech," one explains. "They trade at a mean 12.9 times 2004 earnings," But he also adds that there are variations in their business models, which make them less than perfect comps as well.

Solomon Systech succeeded in listing at a 'single digit discount' to these levels, of between 5% and 9%.

"The company is very happy with the result given the discount was so narrow to its chosen comparables," says one specialist, "especially given investors appetite for big discounts for even fast growing companies."

Good management, a good earnings outlook and solid earnings in the past were all key to getting the deal off the ground, say sources. They state that the company has countered tight supply by diversifying the foundries that make its chips.

Joseph Lo, a technology analyst at DBS Vickers Hong Kong says it is natural to see retail investors scared by volatile markets, but is not surprised institutional demand remained solid.

"We think the company has a good niched give the massive growth in gadgets using LCD displays for which Solomon provides the chip drivers," he says, adding that supply of the LCD driver chips Solomon designs is very tight in the market.

"It's a hot product right now," he continues, "and companies such as LCD screen manufacturers Veritronics are eagerly looking around for suppliers of such LCD driver chips."

"Taiwanese companies in similar areas are predicting 50% earnings growth this year, so it would not be outlandish to predict the same with Solomon," he says.

In addition, he points out that Hong Kong fund managers have a dearth of fabless IC design companies to choose from, with only Fudan Shanghai Microelectronics and Beijing Beida Jade Bird available for investment. Both of these have top lines of around $10 million, one tenth of Solomon's.

One fund manager who preferred to stay anonymous, says the company's biggest challenge could be its technology.

"They have an excellent design team, but their products are not at the cutting edge even though they represent a big chunk of the market," he argues. "How they migrate to the next generation technology will be key".

The company, founded by former employees of Motorola, achieved net profit margins of 7% in 2001, 11% in 2002 and 20.7% last year. Net profits have jumped at a compound annual growth rate of 192% in recent years, says a company spokesperson: $2.7 million in 2001, $6.8 million in 2002 and $22.7 million in 2003.

Sales revenue amounted $37.5 million in 2001, $60 million in 2002 and $109 million in 2003.

Trading starts on Hong Kong's main board on April 8.