Lumena seeks at least $128 million from IPO

After two weeks of investor education, Chinese chemicals company Lumena Resources will kick-off the formal roadshow for its initial public offering today, aiming to become only the fourth company of size to list in Hong Kong this year.

The Sichuan-based company is the world's second largest producer of thenardite, which is a solid form of sodium sulphate and an important raw material for the production of powder detergents, dyes, textiles, glass, kraft pulp and pharmaceutical products. It is seeking to raise between HK$992.8 million and HK$1.48 billion ($128 million to $191 million), according to sources.

The company and its founder are offering a combined 577.2 million shares, which will correspond to about 29% of the market cap at the time of listing. The deal, arranged by joint bookrunners BOC International, Credit Suisse and Macquarie, will include a 15% overallotment option, which could increase the maximum proceeds to $219 million. Though, even if it can pull this off, the total deal size will still be small and is unlikely to attract much interest from larger institutions. Instead, the bookrunners are counting on support from specialty funds with a focus on the chemicals sector, and small- and mid-cap funds focusing on China.

People familiar with the marketing process say there has been some early interest from these types of funds, but add that there will be no formal anchor orders in the book at launch. Somewhat surprisingly, retail brokers have also indicated interest in the deal, which suggests that the strong upward momentum in the secondary market is translating into buying interest in the primary market as well. The Hang Seng Index has rallied 60% since March 9 and on Friday closed above 18,000 points for the first time since early October. Also, two of the other Hong Kong IPOs above $100 million this year have finally edged above their issue prices and started to make investors some money.

Real Gold Mining, which listed in late February and at one point was down as much as 28%, moved above its HK$6.25 IPO price on May 21 and on Friday closed at HK$6.82 -- a 9.1% gain in three months. China Zhongwang Holdings briefly broke above its HK$7 IPO price in mid-May but quickly retreated again and only returned to positive territory this past Friday when it closed at HK$7.15. The Chinese manufacturer of aluminium extrusion products, which is by far the largest IPO in Hong Kong (and Asia) this year, raised $1.26 billion and started trading on May 8.

The third newcomer -- Chinese liquor distributor Silver Base Group -- closed at HK$2.85 on Friday, which is still 17% below its HK$3.45 IPO price. The company, best known for Wuliangye which is a popular brand of Chinese baijiu (white spirits), debuted on April 8. Silver Base and Real Gold both raised just above $130 million from their IPOs.

While there are other companies currently preparing to launch a Hong Kong IPO -- shampoo maker Bawang International, Beijing Building Materials Group, China Chigo Airconditioner, and China Metal Recycling are some that are close -- there will be no other companies going head-to-head with Lumena. In other words, retail investors who want to put some of their cash to work in the primary market right now have few other choices.

On the other hand, Lumena is not a company that can rely on a strong brand name to draw in investors -- be they retail or institutional. In fact, few people are likely to even know what thenardite is.

This is obviously something the bookrunners are aware of and after two weeks of pre-marketing, they seem to have concluded that the deal needs to come at a cheap valuation. The price range has been set at HK$1.72 to HK$2.56, which translates into 5.3 to 7.8 times this year's projected earnings on a fully-diluted basis, using the bookrunners' consensus forecasts. Looking into 2010, the price-to-earnings valuation drops to 3.2 to 4.7 times.

While there are no direct comparables, either in China or abroad, such valuations do seem to leave upside for a re-rating when the economy recovers, and may be enough for potential investors to at least take a closer look.

Lumena's larger rival Nafine, which has an annual production capacity of 1.65 million tonnes, is listed in China's A-share market, but syndicate analysts argue that the quality of its product is not as high as that of Lumena and is not a good benchmark. One syndicate research report uses a 2009 earnings multiple of 9.7 times to calculate Lumena's fair value, which it says is in line with the average multiple of global peers in the chemicals sector. A separate syndicate report puts fair value in a range of 6 to 11 times this year's earnings

Those who do take a closer look will find a high-margin company that has seen a 10-fold increase in net earnings over the past couple of years after a management buyout in 2004 transformed it from a state-owned enterprise into a fast-expanding niche player in its sector. It has a domestic market share of 23%, which translates into 11% of the global market, and is expected to grow its net profit by 19% this year to just above Rmb500 million ($73 million), without taking into account a potential capacity increase in the fourth quarter. In 2010, earnings are expected to improve by close to 80%.

The company, which began operations as far back as 1952, makes three types of products: powder thenardite, specialty thenardite and medical thenardite. The specialty product accounted for almost 70% of its revenues last year, while the medical product made up close to 17% and the powder product about 13.5%. Looking ahead, the company plans to focus on the first two as these have higher margins. It sells more than 98% of its products in the domestic market, but its major customers include the Chinese operations of multinationals like Proctor & Gamble.

Lumena expects to complete the construction of a 200,000 tonne per year production facility for medical thenardite at Muma by the end of this year and a 1 million tonne per year mining and production facility for specialty and powder thenardite in the same area in the third quarter 2010. This will add to its current annual production capacity of 1.6 million tonnes.

The deal will comprise 70% new shares and 30% secondary shares. The latter portion will be sold by chairman Suolang Duoji, who will see his current 71% stake drop to about 40% after the listing. The overallotment option will be all secondary shares. The deal will have the usual structure with 10% set aside for Hong Kong retail investors and a clawback mechanism that will kick in if the retail subscription ratio exceeds certain trigger levels.

The retail offering will open on Thursday and the entire deal will close on June 9. Lumena is scheduled to start trading on June 16.

A Credit Suisse-led consortium will hold about 5% of the enlarged share capital post listing. The consortium extended a $100 million loan to Lumena in June 2007, which came with warrants that will be exercised in connection with the IPO. The loan will be repaid in full, using about 55% of the net IPO proceeds.