Joint bookrunners Citigroup and UBS began formal roadshows on Monday for a government divestment in China Steel. Pricing is scheduled for October 16.
Based on the offer filing and current share price of NT$27, the company will raise a minimum of $590 million and maximum of $980 million. These figures are derived from a base deal size of 820 million shares and leeway to lift the offering by 30% to 943 million shares. With the addition of a greenshoe, this could bring the potential deal size up to 1.225 billion shares. There is a ratio of 20 shares to one GDS unit.
The leads have gone out with a wide price range encompassing a zero to 10% discount to spot and early indications suggest the large size will not hinder tight pricing. Specialists say the mid point of the range is drawing large numbers of arbitrage driven accounts. And while not as liquid as some of the tech stocks, China Steel still has a six-month trading average of $70.7 million per day, meaning that even at the top end of the range, the deal will only represent 12.7 days trading volume.
Roadshows for the deal have started later than originally anticipated because the company decided to incorporate a POWL (public offering without listing) in Japan. This part of the offering is being led by Nomura and could end up with an allocation of between 10% and 25%. There are no other syndicate members.
On the base offer size and greenshoe, the government will sell a roughly 10% stake of its 36.2% holding and on the increased offer size, roughly 12%. It has previously issued GDRs in 1992 and 1997, while the Stabilization Fund sold a 2.58% stake in May.
This latter deal led by Citigroup and Goldman Sachs raised $132.5 million from an 11.98 million unit sale at a 4.73% discount to the stock's NT$20.1 close.
Whereas the accelerated timeframe of the May deal attracted a large percentage of arbitrage driven accounts, the government is hoping full roadshows will encourage a much greater degree of participation by long-term institutional investors this time round. Indeed, one of the main aims of the deal, aside from raising funds to meet the government's budget deficit, is to increase the stock's QFII holding.
China Steel has long been overshadowed by the country's dominant tech companies and more recently by the intense M&A activity in the financial services sector. Foreign ownership stands at roughly 11% compared to nearly 60% for its Korean counterpart Posco.
During roadshows, lead managers have argued that investors would have made much higher returns from holding China Steel and will continue to do so even though the stock is trading at a premium to Posco and has risen 41.26% so far this year. It is currently valued on a price to 2003 book valuation of 1.6 times compared to a one times level for Posco. The sector average (including Japan) stands also stands at 1.6 times.
Part of China Steel's attraction is its very high dividend yield. Just like Chunghwa Telecom before it, this is proving to be one of the major selling points.
The stock currently yields about 9.5% and based on forecast earnings for its December year-end is en route to achieve a 10.6% yield in 2004. Over the past five years, the yield has tracked a low of 5.6% and high of 8.6%.
One of investors' chief concerns lies in dividend sustainability once the government's shareholding drops to a threshold where the money is no longer large enough for it to matter. The company says its high operational efficiency, low gearing (it runs a net cash position) and low capex means it will continue to throw off a lot of free cash.
Over the past three years, the pay-out ratio has moved from 90.5% of net income to 125% and back to 83.3%. At the end of 2002, net income stood at $486.3 million on revenues of $3.13 billion.
The company has long been renowned as one of the most efficient in the sector and is firmly ground at the high end of the steel market. Efficiency is often measured by the production of crude steel per employee, with China Steel improving its ratio from 1,151 million tonnes in 2000 to 1,249 million tonnes as of June 2003.
Management have told investors they believe most rival steel producers in Mainland China are about 15 years behind in terms of the quality of steel they produce. The threat posed by huge capacity expansion on the Mainland is said to be one of two areas investors have asked a lot of questions about.
China Steel says China will remain a net importer for some time. It also believes it is well positioned to serve the market.
Firstly, it is geographically closer to Southern China than its Japanese or Korean competitors and this is where its high-end clients manufacturing electronics and computers are mainly located. Secondly, shipping freight rates have tripled making exports much more expensive.
Currently, 72.4% of its output is consumed domestically and the remainder exported of which about a third goes to China, mainly servicing Taiwanese-owned firms.
The other main issue is said to be industry outlook, since the steel cycle typically runs to two-years and prices have been rising since February 2002. However, according to figures produced by World Steel Dynamics, there is an 85% probability prices will either rise or remain flat over the course of the next year.
