Pre-marketing began yesterday (September 7) for a $300 million to $350 million IPO of red chip China Power International Development (CPI), the flagship arm of the China Power Group, the largest of China's five national independent power producers (IPPs).
Merrill Lynch is sole bookrunner of the deal, which is scheduled to price towards the end of the week beginning October 4 following two weeks of pre-marketing and two weeks of roadshows. Nomura will also run a POWL (Public Offer Without Listing) in Japan, while Credit Suisse First Boston and JPMorgan will be co-leads.
The group will have a freefloat of 33% pre greenshoe. Based on the issue size range and syndicate consensus 2005 profit forecasts of Rmb675 million to Rmb685 million, the deal is being marketed on a 2005 P/E range of roughly 11 to 13 times 2005 earnings.
This compares to a range of about 12 to 16 times 2005 earnings for the three listed IPP's: Datang International, Huaneng Power International (HPI) and Huadian. On a 2005 EV/EBITDA basis, the three span about 6.3 to 8.5 times.
At IPO, CPI will have a smaller asset base and smaller market capitalization than its three major competitors. For example, at listing it will have a market capitalization of up to $1 billion compared to $9.2 billion for HPI, $4.2 billion for Datang and $1.5 billion for Huadian.
In terms of assets, CPI has MW3,010 of attributable installed capacity compared to MW15,275 at HPI, MW6,940 at Datang and MW6,388 at Huadian (all end 2003).
Based on these figures, investors are likely to ask themselves if CPI should trade at a premium to the other three let alone price at one. However, the company and its lead manager are likely to push an IPO and/or trading premium for two main reasons: growth profile and asset quality.
One of CPI's biggest selling points is the potential for asset injections from its parent. These look likely to be much higher than the other IPP's, which means earnings expansion will also be faster.
The CP group has about MW22,200 of attributable installed capacity, a differential of MW19,190 with CPI. By contrast, HPI's parent has MW19,400, a differential of just MW4,000. Datang's parent has MW21,200, a differential of MW14,260.
It is for this reason that some houses rate Datang a better pick than HPI and have the group trading on a 2005 P/E of 14 to 16 times above HPI's level of 12 to 13 times. Some, however, still rate HPI higher than Datang and fund managers say Merrill's for one has HPI on 16 times 2005 earnings and Datang 12 times.
The assets contained in CPI's listing vehicle have been cherry picked from the coal-rich South Eastern provinces of China and number only three power plants.
In addition to this, CPI manages six further power plants with installed capacity of MW3,465 and analysts say at least two of these are immediate acquisition targets. The parent has also granted the group an option to buy a 25% stake in Shanghai-listed Shanghai Power by October 2007.
On top of its acquisition plans, the company is also planning to build three new power stations, which will increase capacity by MW3,468 over the next five years. This fast expansion is being fuelled by China's power shortages and strong GDP growth, the main driver for the equity story of the entire Chinese power sector.
According to analysts power consumption is rising at a CAGR of 9.3% compared to roughly 6% in Korea and 4% in India.
The second main selling point of the deal is that it has much higher asset quality than its listed peers. In 2003, CPI reported an ROE of 17.8% and an ROA of 11.5%. By contrast, the respective figures for the others were 11.5% and 5.1% (Datang), 16% and 10.1% (HPI) and 11.3% and 5% (Huadian).
However, these high figures are less surprising in the context of a list co, which contains only a small number of high quality assets.
Bankers say that investors' two main concerns will centre on coal costs and tariff uncertainty. Where the former is concerned, the whole industry has been hard hit by rising coal prices, which are up by as much as 35% in some regions so far this year. Two of CPI's three plants have derived protection from the fact they are mine mouth facilities, so that at least transport costs have been kept low.
To counteract pressure on the IPP's, the Chinese government has effected two tariff increases so far this year and capped further increases in new contracts to a maximum of 8% over prices as of end May 2004. Analysts say these two tariff increases will buffer 2004 net income, but operating profit margins are still likely to be squeezed and CPI may see its margin drop from 20.7% in 2003 to nearly 18% in 2004.
In 2005, the company will also have a 15% tax rate to contend with, roughly double its current level.
CPI currently has a cost of coal per tonne of $365. Of the three listed IPP's only HPI is higher at $387, while Datang is running at $237. But the company is likely to argue that operating margins could soar towards 30% if coal prices ease and the government sets in place tariff reform. In order to protect economic growth, the government is moving towards a system where there is a much higher correlation between coal prices and tariffs.
However, this system may take up to two years to set in place and at the moment low cost producers receive the lowest tariffs. CPI is consequently penalised for its efficiency with tariffs that are lower than the grid average.
Yet market practitioners believe the deal will be well received. The three listed IPP's appear to have found some price stability after falling steadily for most of this year.
CPI also seems to have been extremely realistic about what it takes to launch a successful deal. The prospective IPO size is now half of what was once talked about. And far from a P/E valuation up in the high teens, as some bankers had feared, it has been set in line with existing comparables.
The deal will also pay a dividend, which is expected to be about 25% of net income. The exact percentage will be confirmed at the beginning of roadshows. Datang and HPI currently yield just under 4%, while Huadian is at 2%.
