United Laboratories prices Hong Kong IPO at the top

Institutional investors get 70% of the $105 million offering from the Chinese drug maker. Retail subscriptions are less overwhelming.
The United Laboratories International (TUL), a Chinese manufacturer of generic Western drugs, has raised HK$825 million ($105 million) from its initial public offering after fixing the price at the top of the indicative HK$2.25 to HK$2.75 range.

This came after the deal was oversubscribed by both institutional and retail investors despite an 11.5% share price drop for its closest competitor during the roadshow and general weakness among recent listings in the same sector. According to a source close to the deal, institutional investors in particular were willing to overlook this because of TULÆs strong growth prospects and its vertically integrated business model.

The latter gives it better control over product quality and production costs and also ensures higher margins versus most of its industry peers, analysts say.

The deal was said to have been covered on the first day of the roadshow, but many investors held off until they had had a chance to meet the management and the conversion rate from the one-on-one meetings was referred to as being ôunusually highö.

ôThis deal is too small to be a momentum play and the people who bought in did recognise that (TUL) is a differentiating player in an otherwise very competitive sector,ö the source says.

ChinaÆs pharmaceutical market is also highly regulated with numerous government price controls, which means it is not without risks no matter how good a market position a company has. Indeed, retail investors were clearly less enthusiastic about TUL than some of the other recent IPOs in the consumer retail and property sectors in the sense that the maximum clawback wasnÆt triggered. There was no shortage of demand, however, and the retail portion of the deal did end up being 27 times covered, triggering an automatic increase of this tranche to 30% of the total deal from an initial 10%. An increase to the maximum 50% would have required the retail tranche to be more than 100 times covered.

The less overwhelming interest from retail investors is likely to have been welcome by institutional investors, as it would have made it slightly easier for them to get a meaningful allocation. Still, the 70% available to them post-clawback was more than 35 times covered with more than 100 investors in the book, sources say. The demand came predominantly from Asia, but with good order flow both from the US and Europe.

TUL, which is based in Hong Kong and was being brought to market by HSBC, sold 300 million new shares, or 25% of the company. There is also a 15% greenshoe of all secondary shares which could boost the total deal size to $121 million if exercised in full.

A source said earlier that the founding Choy family isnÆt keen to part with a bigger portion of the company than it absolutely needs to in order to comply with the minimum free-float requirements. Consequently, they will still hold 75% after the IPO.

The final price of HK$2.75 values TUL at 13.6 times its estimated 2007 earnings, which compares with a market cap-weighted average of close to 20 times for other Chinese drug makers listed in Hong Kong. The valuations vary widely, however, with Wuyi Pharmaceutical at 11 times and China Pharmaceutical at about 39.3 times. The latter, which is considered the TULÆs closest competitor, was quoted at a 2007 price-to-earnings multiple of about 45 at the start of TULÆs roadshow after rallying about 150% since early March on speculation of an asset injection.

Observers say it is possible that some investors chose to go short of China Pharmaceutical and switch into TUL instead to take advantage of the more attractive valuation and the likelihood that the valuation gap between the two will narrow as the IPO discount is ironed out. On Friday, the day after TULÆs offering closed, China PharmaceuticalÆs share price bounced 6.1% from HK$2.75 to HK$2.93.

China Pharmaceutical has a similar product mix to TUL, according to analysts, but lags the listing candidate in terms of margins and the number of products covered by the state insurance programme.

TULÆs main business is to manufacture and sell finished antibiotics drugs as well as the bulk medicine and intermediate products used to produce them. It currently has drug registration approval for 119 products, of which 30 are bulk drugs and 89 are finished products. Among the key drivers for its business is ChinaÆs increase in per capita income, ageing demographics and rising awareness of health issues, which is leading to greater affordability of - and higher spending on - health care and medicines.

The company has a well-recognised brand name, an extensive sales and marketing network and a strong pipeline of 26 new drugs that are expected to come to market over the next three years. It is expecting to receive approval for two penem-type antibiotics (more advanced) in the second half of this year. These two drugs, a human insulin injection for diabetes and a capsule for treatment of hepatitis B, had a combined market size of Rmb12 billion in 2005, suggesting significant growth potential.

Over the past three years TUL has been able to grow its sales at a CAGR of 31.7% while keeping overall Ebit margins steady at 13%-14% despite industry-wide pressure on bulk and finished drug prices. Net profit is expected to increase by 30% to 40% this year from the HK$173.8 million ($22 million) in 2006, driven partly by a production increase at a new intermediate plant, partly by higher prices for intermediate products due to a tight supply situation at this end of the value chain.

The shares are scheduled to start trading on Hong Kong 's main board on June 15.
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