Tongjitang prices US IPO 33% below initial price range

The Chinese medicine maker becomes the first Mainland company to cut the size of a US offering this year as the fall-out from the equity market correction broadens.
The situation for Chinese companies seeking US listings became even more troublesome at the end of last week, when Tongjitang Chinese Medicines was forced to price its initial public offering at $10, 33% below the bottom of the original price range.

US-listed Mainland companies have been hit hard by the volatility and uncertainty that have followed in the wake of the stock market corrections over the past couple of weeks û which was first triggered by a sharp sell-off in Shanghai. So far, however, the demand for IPOs has remained strong, with the hesitation setting in only once they have started trading. Tongjitang is the first Chinese offering this year to see demand wane in the primary market.

ôChina is starting to be perceived as a risk and this was the first listing candidate that had to battle with that shift in sentiment,ö one market watcher says.

Tongjitang, which describes itself as a vertically integrated specialty pharmaceutical company focusing on modernised traditional Chinese medicine, initially hoped to raise up to $167.7 million and offered its 9.87 million American Depositary shares at a price between $15 to $17 apiece.

However, three hours before the deal was set to close on Thursday (March 15), joint bookrunners Merrill Lynch and UBS revised down the price range to $12 to $14 per ADS, offering the first real indication that the book wasnÆt building well.

The company could have chosen to price the deal at $12 even if the price range had stayed at $15-17, since it is possible to fix the price 20% above or below the indicated range without making a new filing with the Securities and Exchange Commission. The fact that they did go ahead and make a new filing would have suggested to investors they were prepared to go even lower.

Not surprisingly this gave rise to a lot of negative energy and the people who were interested in the deal took the chance to talk down the price further. In the end the offer was priced at $10, for a total deal size of $98.7 million. This could increase to $113.5 million if the 15% greenshoe is exercised in full, but that would still be 41% below the intended maximum when the deal kicked off 2.5 weeks ago.

It was initially believed that the companyÆs fast growth rate, its focus on the elderly as its primary patient group û with a flagship drug that is used to treat osteoporosis - and the inclusion two years ago of that drug into ChinaÆs national insurance programme in parts of the country would attract a hoard of international investors wanting to participate in the development of ChinaÆs healthcare industry.

However, it seems in the current environment investors were even more keen to acknowledge the potential risks, including a chance that its main drug would not be included into the national insurance program in any more provinces, the strong dependency on one single drug and the lack of a clear plan on how to use the majority of the IPO proceeds.

They were also said to have been questioning the sustainability of the companyÆs preferential tax rate. As a high-technology company, Tongjitang will pay zero percent tax for another couple of years, but it is unclear what will happen after that û especially after ChinaÆs parliament, the National PeopleÆs Congress, on Friday approved a unified 25% corporate income tax for both domestic and foreign-funded firms.

One source says the deal was almost three times covered at $15, but in order to capture a few quality anchor investors who were willing to guarantee they wouldnÆt immediately sell in the secondary market they had to drop the price as far as $10.

ôThe deal needed to trade well in the aftermarket so as not to ruin the market for other Chinese companies looking to list in the US, and the management, which is quite conservative, was still happy with a price at $12,ö says the observer. ôThe market is in correction now, but they think it will come back (pushing the stock up to that level)," adds the observer.

At $10 the deal was between three and four times covered with more than 100 names in the book, primarily from the US and Asia. About half of that demand came from corporate and private banking clients, but after dropping the price, the bookrunners were believed to have allocated very little to these investors, favouring institutions instead.

The share price did hold up quite well when it started trading on the New York Stock Exchange on Friday, closing at $9.75 after trading in a range between $9.65 and $10.49. The 2.5% decline exceeded the 0.4% drop in the Dow Jones Industrial Average, but was quite modest in comparison with the 12.7% drop Xinhua Finance Media saw on its first trading day a week earlier. Chinese bio-pharmaceutical company 3SBio Inc also fell 7.2% on its first day of trading in early February and has continued to slide since then. As of last Friday it was down 31% from its $16 IPO price, while Xinhua Finance was down 14.2% from its offering price of $13.

According to a source, the bookrunners bought back more than one third of TongjitangÆs greenshoe on the first day to help stabilise the price as more than half the ADS issued in the IPO (5.1 million) changed hands. The stock edged slightly higher to $9.81 in after-market trading.

The company sold 29.5% of the company, with 84.6% of ADS backed by new shares. The remainder was sold by directors and executives of the company. Merrill Lynch is a pre-IPO investor with a 9.9% stake before the offering which it holds through a private equity fund. It didnÆt sell any shares in the IPO, but saw its holdings diluted to 7.4%.

The final price values Tongjitang at 12 times its projected 2007 earnings, which is on par with Chinese medicine companies listed in Hong Kong, like Tong Ren Tang, Shineway Pharmaceutical and Wuyi Pharmaceutical, which are quoted at 10-13 times this yearÆs earnings. This would likely have been a disappointment to the management, however, as initially the company was being marketed in relation to its US comps û specifically American Oriental Bioengineering (AOB), which is another Chinese drug maker listed on the New York Stock Exchange.

AOB currently trades at a 2007 P/E multiple of around 20 times, although this has fallen from about 28 times at the start of TongjitangÆs roadshow after a sharp drop in its share price. All in all AOB fell 24% during the roadshow, including a 25.9% drop last Tuesday, which wouldnÆt exactly have made it any easier to sell a new listing candidate in the same sector.

The initial price range would have valued Tongjitang at a 2007 P/E multiple of 18 to 20.5 times.

In a clear sign that the investor concern is centred around Chinese companies, US investment firm FCStone Group Inc surged 30% above its $24-a-share offer price as it debuted on Nasdaq on Friday. Its IPO was also priced at the high end of the $21 to $24 range.

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