Chemspec opens strong but finishes flat on debut

Chinese specialty chemicals producer Chemspec International priced its initial public offering at the top of the indicated range for a total deal size of $72.8 million after attracting pretty strong demand primarily from US funds focusing on small-caps and China.

According to a source, the offering was about 10 times covered and attracted about 175 investors, but in light of the retraction in the secondary market over the past couple of weeks, the company together with its joint bookrunners, Citi and Credit Suisse, decided not to make use of the opportunity to price above the pre-set range. While there were some indications that investors in Asia would be willing to pay slightly more, there was no certainty in that regard when it came to the key US accounts, which reinforced the decision not to increase the price above the $7 to $9 range.

And this seems to have been the right choice. The stock opened strongly when it started trading last night and was up as much as 16.7% in the first half hour, suggesting that accounts that were not allocated stock in the IPO were buying. There had been some hopes that this would happen as the IPO allocation was concentrated, according to sources, with the top 25-30 investors taking a large chunk of the deal while others got nothing at all.

However, whatever left-over demand there may have been was quickly satisfied and the share price soon started to retreat. After a couple of hours it was back below $9.40 and, having peaked at $10.50, the stock spent most of the rest of the session in a range between $9.20 and $9.40 before taking another hit just before the close. It finished unchanged at $9.

While a drop in the wider market following the Federal Reserve's interest rate announcement shortly after 2pm New York time likely had an impact on the buying interest for Chemspec as well, most of the sell-off in the newcomer took place long before that, indicating that company-specific factors played a bigger role. The pressure continued in after-hours trading when the share price slipped slightly below the $9 IPO price.

The debut of a second Chinese company in the US markets overnight -- Duoyuan Global Water -- was significantly more upbeat. The supplier of equipment for water treatment, including purification and waste water treatment, surged as much as 47% intraday and finished 30% higher. Earlier in the day, Duoyuan had priced its IPO at $16, above the initial range of $13 to $15. It also increased the offering size to 5.5 million ADRs from 5 million, which allowed it to raise $88 million.

The more favourable response to Duoyuan, which was brought to market by Piper Jaffray, may have been due to the fact that its business is less cyclical than Chemspec's. Based on earlier comments from investors and analysts, this was something that came into focus during the marketing of Chemspec as various data indicated that a turnaround in the US economy may be some time off yet.

Chemspec is a leading Chinese contract manufacturer of highly engineered fluorinated specialty chemicals that are used mainly for the production of electronics, pharmaceuticals and agrochemicals. The concerns about the cyclical nature of the business focused primarily on the electronics division, which is the largest of the three and accounted for 55% of revenues in 2008. In its listing prospectus, the company said its sales of specialty chemicals used to make thin-film transistor liquid crystal displays (TFT-LCDs) and other electronics suffered in the first quarter as that industry saw a significant slowdown.

To counter this, the company plans to put more focus on higher value-added specialty chemicals for the pharmaceutical and agrochemicals (mainly fertilisers) industries. It said it believes it is "well positioned to take advantage of increasing market demand for outsourcing of the design and manufacturing of more complex and highly engineered specialty chemicals". But it also projects a more positive outlook for electronics in the third and fourth quarters.

Whether those projections prove correct or not, Duoyuan's business outlook was decidedly easier to understand. The Beijing-based company is tapping into expectations that the urbanisation and industrialisation in China, which is leading to severe water shortages and the pollution of natural water resources, will continue to drive demand for water treatment equipment for the foreseeable future. According to market research firm the Freedonia Group, the demand for water treatment products in China will increase by an estimated 15% per year through 2012.

It is one of the first privately owned companies in China to supply water treatment products, and offer US investors a new way to play the water theme in China.

Chemspec sold 8.087 million American depositary receipts, or 22.3% of its enlarged share capital. The majority of the offering -- 78.2% or 6.328 million ADRs -- were backed by new shares, while the remainder was sold by pre-IPO investors. The deal also includes a 15% overallotment option that could increase the maximum deal size to $83.7 million. All the ADRs sold as part of the overallotment option will be backed by secondary shares coming from members of the management as well as three investors who will receive shares in Chemspec in connection with the IPO by converting various loans and notes that they have provided to/bought from the company's chairman in recent years.

The IPO price translated into a 2009 price-to-earnings multiple of 8.6 times, based on projections by the joint bookrunners, which seems reasonable. However, investors did have some difficulty putting the valuation into context given that there are no listed comparables with a similar business focus. Still, one source noted that the management had done a good job of connecting with investors at the one-on-one meetings during the roadshow and many had come to believe that this may well be a case of a company that is "under-promising but over-delivering".
 
After the increase, Duoyuan sold 5.5 million ADRs, or 26.2% of its share capital. The deal also has an overallotment option of 825,000 ADRs, which could boost the total deal size to $101.2 million.