Tencent gets top dollar

After setting a realistic price range, Tencent is able to price at the top.

Improving market sentiment, renewed interest in the Chinese internet sector and a realistic valuation enabled Tencent to price at the top end of its price range on Friday. Under the lead management of Goldman Sachs, the instant messaging company priced a 420.16 million share deal at HK$3.70, raising HK$1.55 billion ($199.3 million).

This represents 15.5 times earnings based on the mid-point of syndicate 2004 profit forecasts spanning Rmb400 million to RMB450 million ($48.38 million to $54.43 million).

When Tencent first set out on pre-marketing, global sentiment was extremely weak and the company was careful to test the waters with an enormously wide valuation range spanning 15 to 25 times 2004 earnings. By the time roadshows started, the range was honed down to about 11.5 to 15.5 times earnings.

The decision to build a book around a much cheaper valuation that was priced to sell reflected a market where share prices were starting to recover, but investors remained clearly reluctant to commit to new IPO's.

The strategy appears to have worked and the book was able to generate strong momentum and propel pricing towards the top of the range. Retail books closed 154 times covered, prompting the maximum clawback to 50% and the institutional order book topped $3 billion, equating to an oversubscription rate of 17 times based on the original 90% allocation.

About 150 investors participated in the offering, which had a demand split of 56% Asia, 27% Europe and 17% US. Allocations were more evenly balanced, with Asia taking 45%, the US 30% and Europe 25%.

Specialists also note a relatively strong showing from Hong Kong corporates and private banking money, which accounted for just under 30% of the institutional book. Like Meng Niu before it, Tenent's IPO seems to show that while local investors are typically more fickle than their global institutional counterparts, they are currently a lot more confident about the prospects for their own market.

However as one specialist points out, the mood is highly selective and issuers need to take a hyper realistic attitude to pricing. He says, "The door is not yet open for everyone. The market is only willing to look at companies, which are clear leaders in their field, have a strong financial profile and secure market share.

"It will also only tolerate deals where the lead manager is able to balance the needs of both issuers and investors. Issuers that aren't willing to leave any upside on the table will find it very difficult to get deals done."

Tencent consequently priced at a discount to comparable companies in the internet space. The three Chinese portals and two SMS related companies have all performed relatively strongly over the last few weeks and are now trading close or through most analysts' target prices.

At one end of the spectrum is Tom Online, which has risen 12% since mid-May and is now trading at about 16 to 17 times 2004 earnings. Linktone, which is similarly up about 12%, is trading around 25 times 2004 earnings.

The three portals span roughly 22 to 30 times 2004 earnings and have risen 16% (NetEase), 26% (Sohu) and 36% (Sina) over the same time period.

Pre greenshoe, Tencent will have a freefloat of 25%, with US-listed Naspers dropping to a 37.5% stake and management owning the remainder. The company is China's dominant instant messaging (IM) operator with a 74% market share at the end of 2003 compared to Microsoft MSN on 11% and NetEase 4%.

Its IM service QQ has become one of China's better known domestic brands and registered strong growth. Net profit jumped from Rmb140.7 million ($17 million) in 2002 to Rmb322.2 million ($39 million) in 2003 and is forecast to hit up to Rmb450 million ($54 million) in 2004.

First quarter profit came in at Rmb107.3 million ($13 million).

QQ operates on the basis of a closed system, whereby users can only sent messages to other users of the system. Unlike SMS, QQ has a much wider range of applications since it can communicate between telephones and computers.

One of the main measures of success is the number of simultaneous users on the network. The figure hit six million in March this year, double the number of March 2003.

Tencent has a total of 291 million accounts of which 97 million were active subscribers at the end of the first quarter.

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