China Cinda Asset Management, one of China’s four distressed asset management companies (AMCs), has signed up 10 cornerstone investors that will buy close to $1.1 billion worth of shares in its Hong Kong initial public offering, which opens on Monday.
Based on an indicated pre-greenshoe deal size of between HK$15.9 billion and HK$19.0 billion ($2.05 billion and $2.45 billion) that means the offering will be between 45% and 54% covered at launch depending on the final price. More important than the actual volume, however, close to half of the cornerstone demand comes from international institutions, including distressed asset specialist Oaktree Capital Group.
According to sources, Oaktree has agreed to invest about $53 million and has also signed a strategic memorandum of understanding with Cinda with the intention of helping the Chinese company to maximise the opportunities in China’s distressed asset industry.
The other international cornerstones are Och-Ziff, which is taking $200 million worth of stock, Norges Bank, which is investing $150 million, and Farallon Capital (previously known as Noonday), which is contributing $100 million. They are accompanied by six Chinese companies and asset managers, including China Life Insurance and Ping An Insurance.
Their combined support should make other institutional investors more comfortable with Cinda and the valuation of its assets, which include hundreds of billions of dollars of bad and doubtful loans as well as equity stakes in hundreds of unlisted SOEs that it has obtained through debt-to-equity swaps.
The uncertainty about the timing of the disposal of these assets is a concern to potential investors since it means Cinda may face a lot of earnings volatility. Syndicate research reports have also noted that the company has a heavy exposure to China’s real estate and coal sectors, which face their own uncertain outlook.
Overall, Cinda is not an easy business to understand, particularly since it has until now not been that transparent, and being the first of China’s distressed AMCs to seek a public listing there are no obvious companies to benchmark it against.
Having a number of high-profile distressed asset specialists put their money behind the company (aside from Oaktree; Farallon and Och-Ziff also have substantial investment experience in this area) is therefore likely to be viewed as a positive since they can be expected to have put in a great amount of due diligence before making the commitment.
Indeed, one source noted that some potential investors have paid visits to a few of the underlying assets and some have even hired their own appraisers to look at Cinda’s distressed assets and equity holdings.
Despite the uncertainties, bankers say the overall interest in the IPO is already very strong and, aside from the 10 cornerstones, a number of anchor investors are also expected to submit orders when the books open today. One source said the deal could be covered immediately after launch by cornerstones and anchor investors alone.
The reason for the optimism is that Cinda offers a unique exposure to a part of the country’s financial industry that is viewed to have strong growth prospects and that has so far been out of reach for stock market investors. Specifically, the company is expected to be a key beneficiary from the sharp increase in non-performing bank loans and distressed receivables that is projected in the next couple of years, following five years of massive credit injections into the Chinese corporate sector.
The price range does seem to have been set towards the low end of the fair value estimates by syndicate analysts, however, which suggests that, while investors are generally positive towards the company, they are not willing to pay over the top for the shares.
There is also a general belief that the Chinese government wants this IPO to work and therefore is willing to be slightly less aggressive when it comes to valuation. The reason is that it wants to list the other three distressed AMCs as well in the next few years, which would be tricky if investors lose money on the first one. Huarong Asset Management is expected to be next in line followed by Great Wall Asset Management and Orient Asset Management.
All four of these firms were set up in 1999 to acquire and manage a huge amount of non-performing loans (NPLs) from the country’s largest state-owned banks as they prepared for a stock market listing.
Cinda is offering 15% of its enlarged share capital in the form of approximately 5.3 billion new H-shares, sources say. They will be marketed at a price between HK$3 and HK$3.58, which translates into 1.1 to 1.3 times the projected post-money book value at the end of 2013.
The valuation is based on the bookrunner consensus and, at the low end of the range, it will value Cinda at a premium of about 20% versus the average valuation of the Hong Kong-listed Chinese banks, according to one syndicate research report. The high end puts it roughly on par with the Chinese brokers.
The price range implies a total equity value of between $13.7 billion and $16.3 billion at the time of listing. The deal comes with a 15% greenshoe, however, which could increase the total deal size to about $2.8 billion and the potential market capitalisation to $19 billion.
Five percent of the base deal will be earmarked for Hong Kong retail investors, while the remaining 95% will be offered to institutional investors, including the cornerstones.
Business prospects
Cinda has a 35% market share of the NPLs acquired by the four state-owned AMCs since 1999 and is expected to remain the leading buyer of such loans going forward. And since these firms can now buy distressed loans on purely commercial terms – typically at 25 to 30 cents to the dollar and sometimes as low as 10 cents – it is getting easier for them to make a profit.
One syndicate research report forecasts that Cinda’s net profit will grow by 19% this year to about Rmb8.7 billion ($1.4 billion) and by an annual 24% in the next two years, driven partly by the increasing supply of distressed assets, which will lead to stronger revenues for the firm, partly by an acceleration in the sale of its unlisted equity assets.
The unlisted equity stakes are currently carried on Cinda’s balance sheet at the acquisition value, which means there could be a lot of upside when it sells them. Independent valuer American Appraisal estimated the equity value of its 20 largest unlisted holdings at Rmb62.3 billion at the end of June, which equals 223% of the current book value of Rmb27.7 billion. The top-20 assets account for 80.5% of the total book value of the unlisted companies.
There is no guarantee that Cinda will speed up the pace of selling, however, and the company is also not immune to a slowdown in growth, as that would trigger a decline in the value of the assets on its own balance sheet as well.
One recent example of that is the 5.9% stake that it holds in Aluminum Corp of China (Chalco), which suffered an impairment loss of Rmb4.5 billion ($734 million) in the 18 months to June 2013 due to a sharp decline in the share price. Chalco’s A-share price has rebounded 24% since the end of June and a number of Cinda’s other listed equity holdings have also gained, which may reduce the impairment risk in the second half this year, one report says.
Meanwhile, several syndicate research reports note that Cinda has achieved an internal rate of return of 18%-20% on its NPL portfolio, excluding the initial loans that were bought at face value, while the restructuring of distressed debts from non-financial sector enterprises is generating yields of 12%-13%, resulting in a return-on-assets of more than 4%. It is expected to achieve similar returns going forward, they believe.
However, a number of commentators have noted that some of its historic profits and IRRs have been achieved thanks to additional support from the government and are questioning Cinda’s actual profitability.
Bank of America Merrill Lynch, Credit Suisse, Goldman Sachs and Morgan Stanley are joint sponsors for the IPO, which will price after the close of US trading on December 4. The trading debut is scheduled for December 12.
The same four banks are also joint global coordinators together with BOC International, CCB International and UBS, while another 11 banks have been appointed as joint bookrunners. According to a term sheet, the additional bookrunners include mostly domestic Chinese banks from which Cinda is buying its NPLs. Standard Chartered, which is a shareholder in Cinda, has also been given role.
In all, the additional bookrunners are ABC International, Bocom International, CICC, Cinda International Securities, Citic Securities, CMB International, China Merchants Securities, Essence International, ICBC International, Jefferies and Standard Chartered.
The full cornerstone line-up are as follows: Och-Ziff ($200 million); China Life Insurance ($200 million); Norges Bank ($150 million); Farallon Capital ($100 million); Haixia Industrial Investment Fund, which is a Taiwanese/Chinese joint venture ($100 million); Shenzhen Rongtong Capital Management ($100 million); Ping An Insurance ($75 million); Shandong State-owned Assets Investment Holdings ($60 million); Oaktree Capital Group ($53 million); and Guangdong Electric ($50 million).
For more details about Cinda, please see our story published on November 13.
