Analysts all agree that CNOOC's long-term fundamentals make its HK$6.01 ($0.77) IPO price a strong buy. On an EV/EBITDA basis, the main ratio used to determine fair value, the exploration and production company (E&P) is felt to have come at a much smaller premium than its supporters argue it deserves. Priced at 3.5 times 2001 earnings, national counterparts Petrochina and Sinopec are trading at respective levels of 3.1 and 3.2 times, according to figures supplied by the leads.
Yet as one analyst summarizes: "This company is so efficient it should have been valued up at the six to seven times level in line with fast growing global E&P comps such as Australia's Woodside Petroleum."
Ironically, on just about any ratio, CNOOC outstrips the one major strategic investor to its 1.642 billion share deal, Royal Dutch Shell. As a second analyst enthuses: "This is the best company I have ever come across in terms of operating margins, lifting costs, return on equity (ROE), return-on-capital-employed (ROCE), etc, etc. CNOOC commands a 21% ROCE level on a normalized crude oil basis, while Shell stands at 18%. For ROE, we are projecting 28% on 2001 earnings for CNOOC and 17% for Shell."
Analysts note that while the super majors work on operating margins of 30%, CNOOC operates up at the 50% level. So too, while its lifting cost of $3.18 per barrel (three-year average), straddles the industry average, the company actually outperforms the entire sector, because China's tax regime enables it to earn a further $7 per barrel, according to one global analyst.
That its deal needed to be priced at a low valuation can be attributed to one overriding factor - geography. The China risk factor, which scuppered attempts to get investors to examine the company's financial profile the first time it tried to list in October 1999, has reared its head once more. As one syndicate head puts it: "Investors want to record profits on these massive China deals at some point. The last three - China Mobile, China Unicom and Sinopec - are all well down on issue price. The Chinese government has been very realistic this time in understanding that it had to put out a good deal which worked for the market."
Consequently, CNOOC's valuation has been stripped of two of the company's most compelling attributes: its unproven reserves and production sharing contracts with overseas oil companies, for which it receives 51% of any profitable discoveries. Both are viewed as sweeteners and helped propel institutional books to a five times oversubscription level in what have also been difficult global markets.
Bankers report a total of 584 orders in a institutional book that splits 40% Asia, 30% Europe and 30% US. Shell took up its minimum $200 million stake, while the eight corporate investors, which had previously purchased an 8.5% stake at $0.825 per share, will not trigger their top up option, since a dividend paid in December dropped the deemed subscription price from HK$6.43 per share to HK$5.97.
Representing a 20% stake, the primary and secondary share offering was priced at $15.40 per ADS (HK$6.01 per share) towards the top end of a $13.3 to $16.6 indicative range. One unit equals 20 shares, with the overall offering divided between 1.442 billion primary shares and 82.121 million secondary shares. Proceeds will mainly be used for working capital and employee retirement benefits.
Bankers comment that one of the most interesting aspects of the deal concerns the large number of switch orders out of Petrochina and Sinopec, amounting to about 25% of total demand. Some bankers attribute this to what one describes as: "CNOOC being yet another boring oil company, which investors don't want to buy, but don't really have much choice as they need to weight it. A number have just taken the easy option of switching out of Petrochina and Sinopec."
An inability to differentiate between what are viewed as completely different entities infuriates some analysts. "General investors find it very hard to distinguish good oil companies from bad because they don't understand the sector," says one.
A second adds: "Sinopec and Petrochina are restructuring plays on the Chinese economy and will derive growth from bringing their costs down and making assets work harder. CNOOC is a pure growth company driven by the top line. Success will be determined by the execution of that growth."
In this respect, the two main concerns highlighted by investors and also Standard & Poor's in its BBB-rating credit assessment, are the future direction of oil prices and CNOOC's ability to tap its reserves. Previous downturns in oil prices have had a significant effect on net income, since the company has no downstream operations to act as a buffer. When crude oil prices fell to a 12-year low of $10.76 per barrel in December 1998, for instance, the company saw net profit drop to Rmb1.55 billion ($187.14 million) from Rmb 4.9 billion the year before.
To the nine months ended September 30, CNOOC reported net profits of Rmb 7.92 billion on the back of global oil prices, peaking at $37.21 per barrel on the 20th of the same month.
"We expect profits to halve if oil prices drop to our projected low of $18 per barrel," says one analyst. "However, even if you take this into account, CNOOC should be trading on a P/E ratio of nine times 2003 earnings, which still makes it relatively cheap to its peers."
Lead managers further argue that falling oil prices will be offset by growth in the development of unproven reserves. "The main expansion driver will be turning unproven into proven reserves," says one official. "This will grow faster than oil prices will fall."
Yet as one analyst counters: "Executing ambitious growth plans doesn't just happen by default and the market will be watching to see how the company does it. A $4.7 billion capex plan represents a lot of money."
Since 1997, gearing has fallen from 51% to 24% as of 30 September 2000, largely as a result of high oil prices, debt repayment and the issuance of new equity. S&P estimates, however, that funds from operations will not fully cover capex going forwards. As analyst John Bailey further adds: "One of the major concerns has been that a large percentage of CNOOC's reserves are unproven. But we believe that the company has achieved a pretty good hit rate over the last few years; a better performance even than the foreign operators."
Net production from independent operations has also increased steadily over production sharing contracts since 1997 and stood at 49.1% in September 2000, compared to 28.5% in December 1997.
Bankers conclude that CNOOC's undoubted success sends a mixed signal to IPO candidates from the Mainland. That the one company with no SOE taint should have to entice investors with a low valuation relative to its peers, does not bode well for the many that do.
It has also been just over a year since the postponement of the company's first listing attempt and the mudslinging that followed. And yet, the company now finds itself in the invidious position of having raised less money and given away more equity than it would have, had it seen through to completion the sale of a stake reduced from 25% to13.88% a day before pricing, yet still potentially raising $1 billion at $18 per ADS, or HK$6.98 per share.
