Train maker's offering postponed as CSRC stalls

Today's planned launch of the H-share portion of China South Locomotive's up to $2 billion IPO will be delayed and sources say the deal is now unlikely to come before the Olympics.
The plan to kick off the international roadshow for the H-share portion of China South Locomotive & Rolling StockÆs (CSR) initial public offering today has hit a snag as the Chinese regulators have yet to give the final go-ahead to the A-share tranche, sources say. Investors were told on Friday that the deal will be postponed for now, but were given no new timetable.

The two portions, which could raise as much as $2 billion together, are meant to take place almost simultaneously but, under Chinese guidelines, the A-shares have to start trading in Shanghai before the H-shares can debut in Hong Kong. And because the H-shares cannot be priced below the A-shares, it is also widely accepted that the A-share tranche will need to price first. Therefore the bookrunners cannot really start the bookbuilding of the Hong Kong tranche before there is an indicated price range for the A-share offering and that deal is under way.

Sources say the China Securities Regulatory Commission (CSRC) had indicated that it would give the final approval on either Friday, July 18, or the following Monday, but didnÆt do so. The bookrunners have supposedly not been given any explanation for the delay and have not been told when the approval may be forthcoming. The reading of the situation, both by people close to the offering and by investors, is that the CSRC doesnÆt want any more IPOs to occur before the Olympics in the fear that the jittery market sentiment could put them at risk of either failing to draw sufficient orders during the bookbuilding, or being sold off in the secondary market. However, the CSRC itself has not said anything to that effect û in fact it keeps the involved parties guessing when they may be able to launch.

Even if there is still an outside chance that the final approval could be forthcoming over the next few days, one source says there wonÆt be enough time to get the deal done before the Olympics start on August 8. In all likelihood, therefore, this IPO now wonÆt come until late August or early September. According to the same source, once the CSRC approval has been received, the CSR management will need at least three days to pre-market the A-share portion in China and determine the appropriate price range before the bookrunners can set a range for the H-share offering and launch that part of the deal.

While the delay has been widely anticipated for a few days, it is nevertheless disappointing as the Hong Kong market needs a good deal to encourage other issuers to go head, and CSR could well have been that deal given that it is a direct beneficiary of ChinaÆs infrastructure build-out û a sector that is still reasonably popular with investors.

CSR is a manufacturer of everything that rolls on top of ChinaÆs railways, including engines, passenger carriages and freight wagons. Part of its income also comes from maintenance and servicing contracts. This means it is exposed to the same macro issues as China Railway Group and China Railway Construction Corp (CRCC), which construct the actual railways (among other things). Both these stocks have held up relatively well since their respective listings in December and March, despite the troublesome markets.

The Chinese government plans to invest on average more than Rmb100 billion ($15 billion) per year in various railway construction projects until 2020. One syndicate research report notes that with the development of 55 new rapid transit lines in some 14 cities, China will need a total of 6,000 rapid transit vehicles by 2010, which compares with a total production of 654 such vehicles in 2006.

China Railway has tumbled 47% from its high of HK$11.94 in January, but is still 9.5% above its December IPO price of HK$5.78. Since the start of CSRÆs pre-marketing two weeks ago, it has gained 2% and, as of Wednesday last week, it was up as much as 5.5%. Similarly, CRCC has lost 15.9% from its HK$14 high, but as of FridayÆs close was still up 10% versus the HK$10.70 IPO price.

Some reports have suggested that China International Capital Corp (CICC) and Macquarie, which are joint bookrunners for the H-share portion, have been testing the market with a potential 2008 price-to-earnings valuation of 24 to 25 times, although this seems unlikely as it would put the newcomer on par with ChinaÆs railway construction companies. Some investors have also indicated that they wouldnÆt want to pay more than 18-19 times this yearÆs earnings, which are projected to more than double from the Rmb613 million ($90 million) the company made in 2007. Assuming that the bookrunners will apply an IPO discount of about 20% to the talked-about numbers, the final valuation would end up below 20 times. However, as the H-share price will have to be higher than the A-share price, the final valuation will also depend on what the price discovery process among Chinese domestic investors will yield.

CSR is aiming to raise $600 million to $700 million from the H-share portion and another $1.1 billion to $1.25 billion from the A-share portion. The Hong Kong offer will comprise 1.6 billion new shares and will account for about 14% of the company. It will also have a greenshoe that could increase the deal by another 15%. The A-share tranche will account for about 25% of the issued share capital, according to a source. In an earlier filing with the Shanghai stock exchange, CSR said it would sell up to 3 billion A-shares, accounting for up to 30% of its total share capital. The A-share offering is being arranged by CICC and Industrial Securities.

If the current deal size is maintained when the offering is eventually launched, the H-share portion alone will make this the third largest Hong Kong IPO this year after CRCC and rice cracker producer Want Want China Holdings, which raised $2.55 billion and $1.04 billion respectively in the first half of March.
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