Tianhe to set Chinese IPO marker

Can the speciality chemicals company re-lubricate Hong Kong's new listings market?

Tianhe Chemicals is expected to price Hong Kong's fourth-largest initial public offering of the year next Thursday and could be the first major deal to take advantage of the recent improvement in sentiment towards Chinese stocks. 

The Hang Seng China Enterprises Index, which tracks the performance of Chinese shares listed in Hong Kong, has gained about 7% in the past month, while Saturday's better-than-expected manufacturing data suggests China's economic slowdown is stabilising.

For investors, Tianhe could mark a favourable confluence between improved market conditions and a realistic valuation, since the issuer had originally wanted to raise a higher amount -- about $1 billion -- before market conditions soured earlier this year. The targeted issue size is now $636 million to $818 million based on 2.8 billion shares priced at between HK$1.75 and HK$2.25.

The company is offering 11% of its enlarged share capital pre-greenshoe and almost three quarters of the shares are primary.  

Bank of America Merrill Lynch, Goldman Sachs, Morgan Stanley and UBS are joint bookrunners.

The deal has no cornerstone or anchor investors and one drawback may be local investors' lack of familiarity with a sector deemed old school with no direct comparables in Asia. However as one market participant pointed out, "This is the sexy end of an unsexy sector and chemicals specialists are getting excited about it."

A very big supporter of traditional industries such as industrial additives is Warren Buffett who purchased one of Tianhe's main international competitors, Lubrizol, for $9 billion in 2011. 

Comparables

Tianhe is being marketed on an estimated fully diluted price-earnings range of 10.2 to 13.1 times. This places it at a discount to its major international competitors in both the lubricant additives (LOA) and speciality fluorochemicals (SFC) sectors.

The two biggest listed players in each respective sector are US giants NewMarket Corp and Dupont. The former is currently trading at 21.5 times 2014 earnings and its shares have gained 16.9% so far this year, while the latter is at 16.1 times, climbing 7% over the same time period.

Tianhe is China's biggest player in both LOA and SFC, with a 41% market share in the former and 2.9% in the latter, according to Frost & Sullivan. 

The top five LOA specialists control 88% of the world market in LOA -- lubricants that optimise fuel performance and combustion abilities. However, NewMarket represents the only pure play since Lubrizol is unlisted, while Chevron Oronite and Infineum (a joint venture between ExxonMobil and Shell Chemicals) are oil major subsidiaries.

On the SFC side, there are a far greater number of listed comparables including Solvay and Daikin, which are trading at a slight premium to Dupont and Asahi Glass.

SFC products account for a higher percentage of Tianhe's overall revenue mix -- 59% of 2013 revenues, amounting to Rmb 5 billion ($800 million). During its roadshow presentation in Hong Kong, Tianhe's management also said SFC generates higher margins.

With a 30% global share, China is by far and away the world's largest consumer of SFC products. And Tianhe's move into the space is illustrative of the way the country has successfully hauled itself up the value chain.

Two particularly high-growth segments include anti-mar and stain proof coating, which are used in products such as smart phone screens and ATMs to repel water, oil and other liquids. Frost & Sullivan estimates that Chinese demand for both will grow at compound annual growth rates of 19% and 14.2%, respectively, between 2013 and 2018.

Going global

China is the world's largest miner of fluorspar, an industrial mineral used in SFC products. A decade ago it was largely exporting it to foreign players who then provided the value-add before re-exporting their more expensive finished products back to China.

Now the country has its own global player – Tianhe, which has followed the well-trodden route of importing foreign technology, or in this particular case, the brains behind it. Industry experts say the global additives and SFC industry have been turned upside down by China's efforts to entice their best personnel to develop products, which are then sold more cheaply than international rivals.

Hence, Tianhe’s chief scientist is Paul Resnick, a former Dupont fellow, while a former technical consultant at Lubrizol, Ravi Girimaji, runs the LOA division.

During its roadshow presentation, the company also expressed ambitions to use its new technological base to go global either through targeted acquisitions or greater international sales. Its customer base is still largely domestic -- its biggest LOA clients comprising CNPC and Sinopec, which jointly account for 57.2% of that segment’s 2013 revenues.

Tianhe also believes that LOA demand will grow strongly as China uses more additives in domestically consumed fuel to meet stringent emission controls. Currently, LOA accounts for just 5.7% of small engine oil compared with 15.4% in the US.

Tianhe hopes to use the proceeds from its IPO to help it move further up the value chain. To that end management said they intend to continue investing heavily in research and development, while expanding capacity to meet future demand projections. 

From 2011 to 2013, net profit increased by a CAGR of 66.4%, in the process attracting pre-IPO investment from Morgan Stanley and Investec. Post IPO, the two groups' stakes will be diluted down from 9.4% and 6.5% to 8.6% and 6%, respectively.

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