Two pre-IPO investors in China Shanshui Cement Group yesterday took advantage of a strong rally in the company's share price over the past couple of weeks to cash in part of their holdings. And it seemed investors were only too happy for the opportunity to buy into an otherwise fairly illiquid name in a sector that is one of the key beneficiaries of the infrastructure spending generated out of China's economic stimulus package -- never mind that the stock is already trading at record levels.
According to sources, the HK$1 billion ($129 million) placement, which accounted for 9.8% of the market capitalisation, was almost three times covered and was priced close to the top of the offering range, something that is rare these days as investors are typically trying to hedge their bets by buying shares at the widest possible discount.
However, this was the fifth share placement in a Hong Kong-listed company in the past two weeks, which suggests that confidence on the buy-side is improving. During this period there have also been two convertible bonds and a follow-on by a Macau casino operator listed in the US. Most deals are still small, but the $1.92 billion sell-down in Industrial and Commercial Bank of China by Allianz and American Express on Tuesday was proof that larger deals are possible as long as they are in the right name.
"There is definitely a new appetite in the market and people are more willing to pay for names that they like," says one source.
Investors would also have viewed it as positive that both of the sellers in Shanshui -- Morgan Stanley Private Equity and CDH China Fund -- will still hold a substantial number of shares in the company after yesterday's transaction, meaning there is no reason to believe that they are "getting out" because they expect the share price performance to have run out of steam. Indeed, it is hard to fault investors for trying to secure profits wherever they can these days and with Shanshui currently trading 46% above its initial public offering price of HK$2.80, it would have been an opportunity hard to ignore. The cement producer listed in July last year after raising $234 million in an IPO.
Last night's sale comprised 265 million shares which were offered at a price between HK$3.70 and HK$3.80, representing a discount of 7.3% to 9.8% versus yesterday's record close of HK$4.10. The price was eventually fixed at HK$3.78 for a 7.8% discount.
One source notes that the two cents off the top was a nod to some price sensitive accounts that had already moved up their price limits slightly during the bookbuild. But it also showed that the sellers recognised the fact that the share price has rallied 37.5% since last Monday on the back of solid full earnings and a series of target price upgrades by analysts following the stock. About 50 investors, most of which were either long-only or long/short-type funds, came into the deal. The bulk of the buyers were Asia-based, but there was also significant interest from Europe.
Discounts have been creeping lower in recent weeks, and despite its size, Tuesday's placement in ICBC, which was completed following private negotiations with a targeted group of investors as opposed to an open bookbuilding process, required only a 4% discount. However, Shanshui is significantly less liquid as evidenced by the fact that the share sale accounted for about 37-days of trading volume, based on the average for the past three months. A slightly wider discount was therefore needed, sources say.
The stock can be expected to become slightly more liquid after the placement as the free-float will increase to about 38% from 28%. Morgan Stanley will still hold about 17% of the company, while CDH will have a 5% stake. They have both agreed to a two-month lock-up.
Even after the recent gains, Shanshui is still trading at quite a significant discount to some of its peers, which would have been an added incentive for potential buyers. At a share price around $4, the company is still only valued just above 12 times this year's projected earnings, compared with about 22 times for market leader Anhui Conch Cement and 16 times for China National Building Materials, which also has other businesses besides cement production.
Analysts at Macquarie said in a note last week that Shanshui is their preferred pick in the Chinese cement sector, arguing that the company's local-market exposure presents ample opportunities and that the shares offer large valuation upside compared with its peers. "We think Shanshui is a niche player with good volume and margin-expansion opportunities going forward," they said. The bank has an "outperform" rating on the stock and a 12-month target price of HK$6, which suggests 58% upside from the placement price.
The same analysts also noted that the Chinese cement sector continues to provide investors with good leverage into the Chinese recovery story as cement is 100% exposed to the construction cycle. At the same time it has an increased weighting toward the infrastructure segment of the market which remains robust thanks to the government's Rmb4 trillion ($587 million) stimulus package.
Shanshui is China's second largest cement maker and the market leader in the northeastern provinces of Shandong and Liaoning, where the local governments are in the process of reducing the amount of outdated capacity by ordering the closure of smaller players. Analysts estimate that obsolete capacity account for up to 50% of total capacity in these two provinces and data show that a combined 24 million tonnes of capacity was eliminated in Shandong and Liaoning for these reasons last year.
Shanshui said last week that its net profit increased by 154% in 2008 to Rmb539 million ($79 million) on the back of 81% revenue growth and an improvement in gross margins to 21% from 19%.
Surprisingly, since Morgan Stanley's private equity arm was one of the sellers, the US investment bank was not on the deal. Instead, it was Credit Suisse who clinched the bookrunner mandate after what bankers say was a competitive bidding process. Credit Suisse and Morgan Stanley were joint bookrunners on Shanshui's IPO last year.
