Coal in focus as more IPOs hit the Hong Kong market

Investors interested in coal could take their pick yesterday when two companies focusing on coal mining in Mongolia kicked off their marketing to institutional investors. Both companies are looking to list in Hong Kong in the second week of October.

The largest of the two is Mongolian Mining Corp (MMC), a coking coal producer with a large open-pit mine in the Tavan Tolgoi region, which ranks as the world’s largest coking coal deposit. The company is aiming to raise between HK$4.53 billion and HK$5.28 billion ($583 million to $680 million), or as much as $780 million if a 15% greenshoe is also allocated in full.

The second issuer is Winsway Coking Coal, which isn’t actually a coal producer, but a logistics provider focusing on the coking coal industry. It provides transportation by rail and truck to the end-users of the coal, helps facilitate the border crossing into China and provides washing and blending services – a business that has significantly wider operating margins than the production of the coal itself. It is seeking to raise between HK$3.22 billion and HK$4.46 billion ($414 million to $574 million), or up to $660 million including the 15% greenshoe.

Winsway has a strong position in the cross border trade of coking coal and accounted for 55.5% of all Mongolian coal imported into China in 2009. It has a customer base of more than 60 steel makers and coke plants in China.

While the two companies are operating in different parts of the production chain, they are closely linked since MMC currently sells a large portion of its coal through Winsway as it does not have its own washing facilities. However, MMC is in the process of constructing a washing plant, which is scheduled to come online by March 2011, and next year it expects to sell only washed coal directly to the steel mills on the Chinese side of the border.

By cutting out the middle man, MMC estimates that it will be able to raise its selling price from around $78 per tonne that it receives for its unwashed coal on the Mongolian side of the border today to about $150 per tonne. Of course, there will be higher costs associated with the washing (about $4 to $5 per tonne), although the company is telling prospective investors that this will be at least partly offset by cost savings it will make by improving its transportation network.

The company is currently building an asphalt road next to its existing gravel road to the border. The road is due to be mostly finished by the end of this year and will be accompanied by a railroad in 2011-2012, subject to final approval by the government, which will further enhance transportation efficiency.

Winsway is not convinced that MMC will succeed in completely eliminating its washing services, however, and notes that a coal washing plant in Mongolia faces issues such as the fact that the water freezes for a large part of the year. Winsway’s washing plants are all located in China, in warmer climates and close to the end customers, which means it can also sell or use the bi-product from the wash to blend with the washed coal to reduce the final cost for the steel producer – something which is harder to do if you need to transport this by-product hundreds of kilometres. MMC argues that there are coking coal washing plants in Canada that operate in a similar climate without a problem, and notes that the project is accompanied by a detailed feasibility study which suggests there is enough water available to operate a plant with a capacity of up to 10 million tonnes.

Because both companies are in the market at the same time, however, investors don’t necessarily have to make a bet on which one is right -- whether MMC will be able to grow its margin and whether Winsway will be able to protect its businesses and margins. Rather, they can buy both, using one as a hedge against the other, the idea being that the overlapping business between the two companies is a zero sum game.

Both MMC and Winsway also have a strong backing both domestically and internationally already, which should make investors more comfortable about investing in these deals. MMC is controlled by the MCS Group, a Mongolian conglomerate that is the largest tax payer in the country and a market leader in numerous businesses. Its standing in the domestic economy was evident by the fact that the Mongolian finance minister attended the investor lunch presentation in Hong Kong yesterday. The group is currently constructing a Shangri-La hotel in Ulaanbaatar together with Hong Kong’s Kerry Group and is in partnership with Coca Cola for a Coke bottling plant. Following the IPO, MCS’s shareholding will fall to 45.3% from 57%.

The Kerry group, through Kerry Holdings, has also made a direct investment into MMC and will hold 8.3% of the company post listing. Another 3.2% will be owned by the European Bank for Reconstruction and Development (EBRD), which in May this year also provided a $180 million secured loan to the company.

Meanwhile, Winsway got an injection of international money in April 2010 when Hopu, a China-focused private equity fund run by former Goldman Sachs investment bankers Fang Fenglei and Richard Ong; China Minmetals, a state-owned Chinese trader and producer of metals and minerals; Hong Kong-based investment company Silver Grant; and Japanese trading company Itochu all took a stake in the company. Hopu, which is the largest among these investors, holds about 13% of the company before the IPO, but will sell part of that if the greenshoe is exercised.

Jay Hambro, the chief investment officer of London-listed mining group Petropavlovsk and the son of Petropavlovsk’s founding chairman Peter Hambro, has a seat on Winsway’s board. Jay Hambro is also chairman of IRC Limited, an iron ore mining company located in Russia, just across the border from China, which is in the process of being spun off from Petropavlovsk for a separate listing in Hong Kong.

Industry-wise both MMC and Winsway are faced with the expectation of a slowdown in the growth of steel production in China. Although with the demand for steel expected to continue to rise in absolute terms, this really shouldn’t be an issue for some years yet. One source also noted that if China continues to clamp down on inefficient and non-environmentally friendly steel plants, the Australian coal producers may well redirect their exports to India, where demand for coal is also on the rise, leaving the Mongolia-based coal companies to take advantage of their lower transportation costs for feeding coal into China.

In fact, the greater challenge to these two listing candidates could turn out to be the numerous other IPOs that are currently in the market and are vying for investor attention. Another challenge may be to convince investors to look beyond the poor performance of SouthGobi Energy Resources, a Canadian company with coal mining operations in Mongolia that obtained a dual listing in Hong Kong in January this year. SouthGobi has struggled to meet the projections it laid out at the time of the Hong Kong share offer and its share price is currently trading 40% below its listing price.

MMC is banking on the significant ramp-up of its production capacity in coming years to convince investors of its growth potential. From a planned production of 3.8 million tonnes this year, the company is in the process of upgrading its capacity to about 7 million tonnes next year, 10 million tonnes in 2011 and 15 million tonnes by 2015. Clearly there is a lot of execution risk here, but the management has a track record of beating its own targets and, as a result, MMC has attracted a lot of initial interest.

The company is offering 20% of its enlarged share capital in the form of 719.4 million shares, of which 83% are new and 17% secondary. The price range has been set at HK$6.29 to HK$7.34, which translates to a 2011 price-to-earnings ratio of 11.6 to 13.6 times.

The deal, which is being arranged by Citi and J.P. Morgan, is due to price on October 4 (US time) and the trading debut is scheduled for October 13.

Meanwhile, Winsway is offering 25% of its share capital, or 990 million new shares. The 15% greenshoe will be made up entirely of secondary paper. The price range has been set at HK$3.25 to HK$4.50, which equals a 2011 P/E ratio of eight to 11 times.

The final price will be determined after the US market closes on September 29 and the trading debut will take place on October 11. Deutsche Bank, Goldman Sachs and Bank of America Merrill Lynch are joint bookrunners with the first two also acting as joint global coordinators.