Roadshows began in Hong Kong yesterday (September 27) for a Bt24.3 billion ($588 million) to Bt28.8 billion ($697 million) IPO of Thai Oil, the refining arm of state oil giant PTT. The flotation, which is scheduled to close on October 12, appears to heading towards a blowout success after being timed to perfection.
The 900 million share deal is being pitched on a forward P/E range of 6.2 to 7.3 times, which places it at a slight discount to regional comparables averaging 8.3 times 2005 earnings. Specialists say the transaction's biggest selling point is a valuation underpinned by soaring refining margins, which continue to surprise analysts on the upside.
Thai Oil enjoys higher gross refining margins than the regional average. It is currently said to be hitting $10 per barrel per day (bpd), up from $9.20 bpd in the second quarter, an average of $3 during 2003 and a low of $1 in 2001.
Few foresaw a spike of quite such a huge magnitude and a number of houses have recently been revising up their pan regional forecasts. Many now believe the cycle will extend out to 2006, although they also warn that margins will not be able to maintain their current unprecedented peaks and will trend down to $5 to $6 over the next two years.
This, however, would put them back on a par with the early 1990's when the sector last boomed in Asia.
The current upswing has been driven by a fortuitous combination of circumstances that originated with the Asian financial crisis of 1997. The long recovery process from the crisis meant little new capacity was put in place throughout the region and none in Thailand where refineries are now operating at full capacity in the face of demand that continues to grow strongly. Thailand, for example, is the region's third fastest growing energy market after China and India.
At the same time refined oil product prices have outpaced crude oil prices, which are themselves at record highs.
As Credit Suisse First Boston commented in a research piece in late July, "Current refining margins reflect the best on the demand side and the tightest supply in the last four years, brought along by limited capacity growth."
The key question for investors now is how long this situation can be sustained and how far margins will fall as new capacity comes on stream. CSFB said it believes margin pressure is likely. "We see capacity growth picking up in both India and China and demand is at risk from a China slowdown, Japanese nuclear power plant start-ups and a general slowing of the global economy."
Yet analysts believe it would take a major regional shock along the lines of the financial crisis to push margins back down to $3 bpd again and many argue that market continues to underestimate China's insatiable demand for oil, despite the government's stated desire to cool the economy.
In its IPO research, JPMorgan is said to be forecasting a regional average gross refining margin of $6 in 2004, dropping to $5 in 2005 and rising back to $6.5 by 2008. Morgan Stanley is at similar levels and believes margins will average $5 to $5.45 in 2005 and $5.25 to $5.55 in 2006.
Both banks are lead managers of the IPO alongside Merrill Lynch, Bualuang Securities, Finasia, Phatra Securities and SCB Securities.
The syndicate has assigned a fair value range of $1.3 billion to $1.9 billion to the deal, which means it will be priced at an IPO discount of 13% to 26% based on the mid-point of this range. The share price has been set at Bt27 to Bt32 and the company is offering 50% of its enlarged share capital, although it will have an effective freefloat of 35% to 38% depending on the exercise of the greenshoe.
This because some of the selling shareholders want to re-subscribe to the IPO and have an option to buy up to 15% of the secondary shares on sale. They will then be subject to either a staggered lock-up over one-and-a-half years, or a full two-year lock-up.
This unusual twist to the IPO structure derives from the fact that the vendors are a group of creditors housed under a Mauritius SPV, which is being dissolved as a result of the offering.
However, some of this creditor group, which bailed out Thai Oil after the financial crisis, remain keen to hold onto the company's stock. So too, PTT does not want to get diluted and will continue to own 49.99% of the company post flotation.
Both these facts are likely to be highlighted by lead managers as an additional reason why fund managers should believe the current cycle has further upside.
In total, Thai Oil will sell 900 million shares of which 60 million are being sold to retail investors, 638 million to foreign and domestic institutional investors and 202 million to existing shareholders including PTT and its affiliates Thailube and Thai Paraxylene. There is also a split of 90% secondary shares and 10% primary shares.
Like most Thai stocks, the company will pay a dividend based on a pay-out ratio of 25% of net income. Specialists say the stock is likely to yield about 4%.
They also say fund managers are focusing on P/E as the main valuation metric because the refining cycle has got to the stage where companies are reaping peak profits.
Pure comparables are said to be few and far between and observers believe this rarity value will give the deal an additional push. The syndicate has used a basket of stocks comprising SK Corp and S-Oil from Korea, Sinopec Zhenhai from China and Caltex Australia. Together the four are said to average a 2005 P/E of 8.3 times.
Because Thai Oil sells 90% of its product domestically, the stock is being pitched as a play on domestic growth. Current capacity stands at 220,000 bpd and the company has a dominant 21% market share. It is also running at 107% of capacity, the highest among domestic refiners.
During roadshows presentations, the company has said it hopes to increase capacity to 270,000 bpd by the fourth quarter of 2006. It also says that it will do so by de-bottlenecking rather than greenfield projects which would significantly push up its capex costs.
But its biggest balancing act will lie in convincing fund managers that countrywide new capacity additions will not upset gross refining margins that have only just recovered from the financial crisis. As such one of fund managers key considerations will be how seriously Thailand wants to topple Singapore as Asia's major refining hub and what this may do to the delicate supply/demand balance.
In the summer of 2003, prime minister Thaksin Shinawatra said he aimed to turn Thailand into the region's premier oil refining and trading hub within five-years. Since then the government has announced plans for a giant eighth refinery in southern Thailand with a capacity of up to 500,000 bpd.
This would add nearly 50% to Thailand's current capacity of just over 1m bpd and see the country eclipse Singapore, which produces about 1.3 million bpd. In July this year, the minister of energy said that PTT would be the core investor in the project, although the partially government-owned company has subsequently denied it.
PTT also recently purchased Shell's stake in Rayong Refinery, which produces 145,000 bpd. Together the two refining arms of Thai Oil's parent could completely eclipse it.
Lead managers have understandably been playing down the likelihood of this project coming to fruition. "It's been talked about for some years and has still not even been given the green light yet," says one observer. "And even if it does go ahead, it will take a long time to come on stream."
Lead managers have further argued for a continuation of the current cycle on the basis that Asian refiners are paranoid about committing to new capacity in a peaking cycle. "They all got caught by the financial crisis when lots of new capacity came on stream just as everything was crashing. It's made everyone very wary."
Thai Oil came unstuck because of a dollar denominated balance sheet, which was unable to withstand the precipitous fall of the Baht during the second half of 1997. The company stopped paying interest on its debt in 1998 and came to a restructuring agreement with its creditors, which involved $2.2 billion of debt.
Its last debt haircut was completed in the second quarter of this year, resulting in gross debt dropping to $800 million and its gearing ratio to just under 100%.
Over the past few years it has re-built profitability after margins hit a low towards the end of 2001. In 2003 net income totalled Bt6.75 billion. By the end of the first half of 2004 it was almost up to the same level: Bt6.63 billion.
Merrill Lynch is said to be forecasting net profit of Bt12.46 billion for the whole of 2004, dropping to Bt9.23 billion in 2005 and Bt9.16 billion in 2006.
To buffer itself against a future downward cycle, PTT has also been moving down the product chain and has purchased petrochemicals producers Thailube and Thai Paraxylene.