State-owned power generator China Datang Group revived the initial public offering of its environmental protection and energy conservation business on Tuesday: its second attempt to list the business after postponing an earlier deal late last year.
Initial terms show that Datang Environment Industry will raise a maximum of HK$2.56 billion ($330 million) on a pre-shoe basis, based on an indicative price range of HK$3.55 to HK$4.74 per share.
The company is selling 540 million shares, equivalent to 18.37% of its enlarged share capital, with an upsize option encompassing an additional 81 million shares.
Syndicate bankers said the company decided against a formal deal launch after completing premarketing sessions in December last year. It then pulled back from launch over concerns that stock market sentiment could weaken towards the end of the year.
US election uncertainties
This time round, senior management appears confident it can steer through any market volatility resulting from the US presidential election.
According to the deal’s timetable, Datang Environment will price its IPO on November 8, just hours before the polls close in the US. This means the company will be able to lock in orders ahead of the outcome, although investors can technically withdraw their orders anytime before the November 15 settlement and trade date.
The company is pitching a cautious valuation in face of potential market volatility. Based on the indicative terms, Datang Environment will have an implied valuation of about $1.8 billion at the top end of the price range, or a 42% discount to the most aggressive syndicate fair value estimates of $3.1 billion last year.
In terms of price-to-earnings, the deal is being pitched at 7.3 times to 9.8 times 2017 earnings based on syndicate consensus estimates, according to a source familiar with the situation. By comparison, syndicate banks assigned a fair value of about 14 to 20 times earnings during the premarketing sessions last year.
Environmental protection
Datang Environment is listing at a time when China is playing an increasingly important role in trying to mitigate climate change. Beijing is modernizing its coal power plants with a targeted 60% cut in emissions by 2020.
Since the beginning of this year, the mainland authorities have implemented more stringent emission standards for coal-fired power plants.
For example, the cap for sulphur dioxide emissions will be reduced to 35 mg/m3 by 2018 from 100 mg/m3 in 2014, while nitrogen oxide emissions will be capped at 50 mg/m3.
As a result, many independent power producers have outsourced de-sulfurization (DeSOx) and de-nitrification (DeNOx) – processes that allow coal-fired power generators to reduce emissions of sulphur dioxide and nitrate gases – to third party companies.
Energy conservation contractor
Datang Environment says it is China’s biggest DeSOx and DeNOx contractor with a 21.6% and 38.2% market share in each sector at the end of 2015. It enters into concession agreements with power producers and helps them achieve gas emission targets and improve operational efficiency.
Its business model means its earnings will be closely correlated to the power sector. Any surge in total power supply should benefit the company.
However, China’s overall power supply has been under pressure as a slowdown in manufacturing activity continues to weigh on demand. Power producers have been cutting production in the face of rising coal prices.
Beijing’s push into renewables is also prompting producers to turn away from coal-fired power generation, thereby reducing business opportunities for energy conservation contractors.
Datang Environment does not appear to have been impacted by this factor so far given its close ties to the China Datang Group. Datang International, the group’s power generation unit, said total power supply increased 1.2% in the first nine months of the year compared to the same period last year.
Last year, Datang Environment generated 68.1% of its sales from China Datang Group, its highest level over the last three years. While that ensures a stable revenue stream, it also implies concentration risk.
Scarcity
Nevertheless, the group benefits from rarity value among Hong Kong-listed stocks.
Guodian Technology & Environmental Group, which counts energy conservation as its second largest business, is Datang’s only Hong Kong-listed competitor. But it has become a less direct comparable after selling the bulk of its DeSOx and DeNOx assets to its parent in February this year.
Shenzhen-listed Beijing SPC Environmental Promotion is the second largest DeSOX contractor in China with a 16.8% market share and third largest DeNOX contractor in China with a 15.6% market share at the end of 2015. Year-to-date it has traded down 19.83% to Monday’s close.
Datang Environment has secured four cornerstone investors for the IPO. They include Anbang Insurance ($65 million), China Life Insurance ($50 million), China Chengtong Holdings ($30 million) and China Three Gorges Corporation ($29 million).
Collectively their investment accounts for 50.3% to 60.4% of the total deal on a pre-shoe basis. There will also be a 90%/10% split between institutional and retail investors.
Citic CLSA is the sole sponsor of the IPO. Deutsche Bank, China Merchants Securities, Haitong International, HSBC, ABC International and BNP Paribas are joint bookrunners.
