Henan-based WH Group began pre-marketing on Monday for a $4.8 billion to $6 billion initial public offering of shares that will rank as one of Asia’s largest in four years.
Early indications suggest that many long-only funds are extremely positive on the underlying story but considerably less keen on what they consider to be a punchy valuation.
Key to the final outcome will be how much pricing power they have over the Chinese company, which needs to get its IPO away to reduce the debt it took on board when it bought US-listed Smithfield Foods in 2013.
As a result of the acquisition, valued at $7.1 billion including debt, net gearing — debt net of cash relative to total shareholder funds — rocketed to 286% in 2013. But that should fall back to around 14% if its Hong Kong listing is successful.
Sources say the company formerly known as Shuanghui International wants to use the IPO proceeds to reduce its debt load by $4.5 billion. This will comprise the repayment of a $4 billion three-year syndicated loan, $389 million in unsecured senior notes and $158 million of Smithfield’s inventory revolver.
Using blended syndicate figures the company has been assigned a fair value of $20.3 billion to $25.2 billion. A blended syndicate 2014 net profit forecast of $1.075 billion means the company is being pitched on a price-to-earnings ratio of 18.9 to 23.44 times estimated 2014 earnings.
Add on an IPO discount of up to 10% and the company could be formally marketed at a range of about 17 to 21 times estimated 2014 earnings.
Where are comparables trading?
In analysing the company, investors have plenty of benchmarks to choose from including two listed entities of the WH Group.
Its Chinese pork operations come under Shenzhen-listed Henan Shuanghui Investment and Development, which is currently trading on a forward p/e of 17.5 times, according to Bloomberg. Its European packaged meat business, meanwhile, is held by Spanish-listed Campofrio Food Group, which is trading at around 19.88 times.
Its third main business arm, the US pork operations, is run by Smithfield Foods, which was trading at about 13.2 times estimated 2014 earnings at the time of its de-listing last autumn.
WH Group is, therefore, hoping to convince investors that the whole deserves to be valued at a premium to the sum of its parts. Pushing the valuation to the upper end of the range will also require WH Group to persuade investors that it should be valued as a Chinese consumer play rather than a global meat business.
The average blended p/e of listed global meat companies is about 17 times 2014 earnings, although there is quite a bit of clear water between America’s Tyson Foods (more of a beef play) on about 14.91 times and Japan’s Itoham on 24.3 times.
Closer to home, Chinese pork producer Huisheng International raised $31.7 million in February through a Hong Kong listing. The retail portion of the book was 2,000 times oversubscribed after being swamped by retail investors but its aftermarket performance has been disappointing.
Its shares are down 12% since its February listing and the stock is trading at just over six times 2013 earnings. Syndicate bankers are hoping to avoid using it as a comparison on the grounds that it is too small.
Instead they point to Chinese snack food giants Tingyi Holdings and Want Want China Holdings. Both of the Hong Kong-listed stocks have high valuations reflecting their popularity as plays on the Chinese consumer growth story.
Tingyi is currently trading around the 30.66 2014 earnings, according to Bloomberg, while Want Want is on 26.04 times.
Selling points
In their pre-IPO research, syndicate banks argue that WH Group deserves to come at a premium to other global meat businesses because the company benefits from a dominant global market share – one that is likely to get ever larger thanks to Chinese government-sanctioned domestic consolidation.
However, they also acknowledge the inherent volatility of the hog-rearing business, concluding that WH Group should be fairly valued at a 5% or so discount to more stable entities such as Tingyi and Want Want.
These kinds of earnings fluctuations are clearly reflected in Smithfield’s net profit, which fell from $521 million in FY2011 to $184 million in FY2013.
Analysts attributed this to rising feed costs, particularly corn prices, as well as US-government imposed export restrictions. The porcine epidemic diarrhoea virus (PEDV) also hit the industry in 2013.
But likewise, syndicate banks now expect Smithfield’s earnings to increase to $481 million in FY2014 because of falling corn prices, as well as merger-related benefits, including lower financing costs (2% per annum via HK-based banks rather than 6% average annual costs in the US) plus increased exports to the Chinese arm.
Rising hog prices are good for the US arm, which produces the pigs but not so good for the Chinese arm where the pigs are consumed. Yet one of the IPO’s biggest selling points is the parent group’s ability to balance global supply and demand given that it now dominates both ends of the chain.
Over the short-term, supply shortages in China can be bridged by imports from the US where the cost of raising hogs is 40% cheaper. This price differential also points to some potential upside by improving efficiency levels in China where 58% of farms currently produce just 49 pigs each per year.
The Chinese government has been pushing hard to improve efficiency and better quality standards to improve margins and mitigate new food scandals.
As a result, the number of slaughterhouses has dropped from 28,560 in 2008 to 9,989 in 2013. The government’s new target is to cut capacity by a further 50% in the next two years.
WH Group hopes to benefit from this trend.
At the moment it has an 8% market share in the pig slaughtering business, the dominant Chinese player. However, Smithfield has a 31.7% market share in the US where the industry is already far more concentrated and the top five players control 70% of the market.
Overall, WH Group’s revenues are split: 3% hog production, 43% fresh pork (slaughtering business) and 54% packaged meat. On a global level, the company holds the number one position across all three segments, with a respective market share of 1.5%, 3.1% and 3%.
It believes it can derive multiple synergies as a result of the merger, which will lead to a compound annual growth rate in net profit of 30% through to 2016.
Two of these comprise technology transfers from Smithfield to Shuanghui to improve the latter’s productivity as well as using Smithfield’s brand name to expand market share in China, where consumers often prefer imported food because they believe it is safer.
Together, syndicate banks believe these synergies will boost the combined group’s net profit by 1%, 5% and 6%, respectively, from 2014 through 2016.
But the biggest selling point of all is likely to be the China consumption story.
The country accounted for 75.34% of global pork consumption in 2012 and is expected to contribute to 80% of global growth over the next five years.
Re-rating the Chinese meat sector
A re-rating of the Chinese meat sector is likely to hinge on investors’ belief in significant improvements across the farm-to-market supply chain. Previous doubts about food safety were one of the chief reasons why Henan-based pig products manufacturer Zhongpin delisted from Nasdaq in 2013.
The company said it was going private after consistently trading at a discount to Smithfield Foods, although news reports questioning its financial statements helped pushed the stock down to as low as 3.9 times forward earnings in 2011.
China will also need to avoid stories such as the one from last March, when 16,000 dead pigs were dumped into the Jiapingtang River.
Deal structure
One of the main unknowns with WH Group’s IPO is whether any of existing private equity shareholders will divest their stakes during the IPO. Sources say the majority of the deal will be primary shares but there are likely to be some secondary shares.
The biggest shareholder is Shanghai-based CDH group, which owns 33.7%. Other private equity investors include Goldman Sachs, Temasek and New Horizons.
The IPO will have the standard split between institutional and retail investors of 95% and 5%. There is also a public offering without listing in Japan run by Daiwa and Nomura.
Formal roadshows will begin April 10, with pricing provisionally scheduled for April 22.
One of the deal’s standout features is its enormous syndicate, which includes seven sponsors and 15 global coordinators. Sponsors comprise: Bank of China International, CITIC Securities, DBS Vickers, Goldman Sachs, Morgan Stanley Standard Chartered and UBS.
Joint global co-ordinators are Bank of America Merrill Lynch, Barclays, CICC, Credit Suisse, Deutsche Bank, ICBC International, JP Morgan and Rabobank.
