ZTE gets tight discount

Market momentum propels ZTE''s Hong Kong offering to tight discount against outstanding A shares.

ZTE Corp became the first A share company to complete a secondary listing on the Hong Kong Stock Exchange on Friday (December 3) raising HK$3.1 billion ($398 million) from a deal led by Goldman Sachs. The Chinese telecoms equipment manufacturer priced a 141 million share offering at the very top end of its HK$17.5 to HK$22 range after securing roughly $10 billion in retail demand and $7.6 billion from institutions and corporates.

Based on Thursday's closing share price of Rmb26.94, the new deal came at a 12.88% discount and at 12% based on the stock's 30-day average in China. This was far tighter than the 20% to 30% discount most analysts had been expecting. Indeed of the 29 companies, which have listings in both China and Hong Kong, the average discount currently stands at 45%.

ZTE's success would appear to show that not all China listed companies should fear a valuation contraction if they want to secure a secondary listing overseas. Indeed, news that ZTE had priced at the top of the range, prompted strong buying interest in China on Friday, with the stock spiking 4.2% on the day to close at Rmb28.10. This in turn widened the valuation differential between the two to 17%.

At HK$22 per share, ZTE has been priced at 15.4 times 2005 earnings on a post money, post shoe basis. However, this earnings forecast is based on Hong Kong Gaap figures, which differ from the China Gaap figures traditionally used to value ZTE by analysts on the Mainland. Using Chinese Gaap forecasts, ZTE has been priced at 20 times 2005 earnings on a post money, post shoe basis.

At this level, its looks fully valued relative to global telecom equipment giants such as Nokia, Motorola, Lucent and Ericsson, which are currently trading in a band of 18 to 20 times 2005 earnings. ZTE's only direct comparable in terms of domestic manufacturers - UTStarcom - is listed on Nasdaq and trading in a wide band of 10 to 17 times earnings.

Specialists believe the deal did well for two main reasons. Firstly, there is clearly very strong momentum in the market, with retail books closing just over 250 times oversubscribed and prompting clawbacks to 50% of the deal. The other 50% was allocated to institutions and corporates, with this order book closing 30 times oversubscribed on a post clawback, post shoe basis.

The institutional book is said to have had a demand split of 66% institutions and 34% corporates and high net worth clients. About 25 accounts placed orders for more than $50 million and there was a geographical split of 50% Asia and 25% Europe and the US.

Secondly, specialists say that the deal was also well received because management performed well on roadshows despite no-one speaking a word of English. Both the President and CFO have worked at ZTE for over a decade and consequently know the company inside out.

The deal was also underpinned by Chinese news reports earlier this week that the government may be moving towards some kind of resolution on the issue of how many 3G licenses to hand out and which technologies to employ.

One Chinese newspaper has reported that the government has decided against forcing mergers between the four listed operators - Netcom, Telecom, Mobile and Unicom. Instead, Mobile will be awarded a W-CDMA license (building on its GSM platform), Unicom will be awarded a CDMA2000 license and both Netcom and Telecom will deploy China's own 3G standard - TD-SCDMA.

Some analysts believe this represents a good compromise, as it will avoid excessive competition between the four at the outset since TD-SCDMA is not yet commercially viable. Yet in the long-run, they believe it makes sense for Netcom and Telecom to use TD-SCDMA as China has allocated a lot of spectrum to this standard; is clearly very keen to push its own national technology and; TD-SCDMA is better adapted for the broadband networks run by both operators.

Analysts also believe the news - if it proves to be the case - is good for equipment suppliers like ZTE, Huawei and UTStarcom. ZTE in particular, should see its domestic profitability underpinned by two revenue streams - 3G and PHS. If Netcom and Telecom do no get 3G licenses straight away they will continue to support equipment supplies to their existing proxy mobile systems - PHS.

However, some analysts still believe the government is unlikely to resolve the 3G issue and award licenses for at least another six months. They add that it will take equipment manufacturers at least another six months to a year beyond that to have equipment ready for installation and testing.

In the meantime, ZTE has argued that it will continue to boost profitability and growth by expanding its international operations. It is forecasting that revenue from international operations will jump from 13.4% in 1H04 to 40% by the end of 2006.

Post listing and greenshoe, ZTE will have a freefloat of 16.7% in Hong Kong and 31.5% in China (down from 37%).

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