The retail component of an initial public offering worth up to HK$2.79 billion ($360 million) by the world's second-largest 200mm wafer manufacturer, Hua Hong Semiconductor, opens in Hong Kong on Friday.
The 228.7 million share deal comes at a time when all eyes are on the protest movement in Hong Kong and its potential repercussions across the city, mainland China and global financial markets. However sources close to the deal remain confident in the strength of the order book.
This belief is based on the extensive work the company conducted with a number of key global accounts in the run up to roadshows and the correspondingly narrow valuation range, which reflects the level of those investors' interest. As a result, the deal is being pitched on a tight range of 0.9 to 0.98 times 2015 book value and is said to have been comfortably covered from day one.
The deal is composed entirely of primary shares and has a price range of HK$11.15 to HK$12.20 per share, according to a term sheet seen by FinanceAsia. It will close on October 8, with pricing due after the end of the New York trading day.
The Goldman Sachs-led offering also has a greenshoe of 34.3 million primary shares, which could push total proceeds up to HK$3.2 billion ($410 million). Post greenshoe, the company will be issuing 24.6% of its enlarged share capital.
Its existing share register includes technology stalwarts Li Ka-shing and Taiwan's Wang family. Both were investors in Grace Semiconductor, which was taken over by Hua Hong in 2011.
The new investor register will also include two cornerstone investors, comprising Shenzhen-listed fabless company Tongfang Guoxin Electronics, which is investing $15 million, and Nasdaq-listed fabless client Cypress Semiconductor, which is picking up $10 million. They are subject to a six-month lock-up.
Pricing benchmarks
Hua Hong is being pitched at a discount to the entire 200mm wafer sector. The IPO is coming at a 18% to 25% discount to SMIC, which is currently trading at 1.2 times estimated 2015 book value.
However, Hua Hong's fair value range spans 0.9 to 1.3 times, which means syndicate analysts believe it should trade through SMIC in the secondary market. For many investors this is likely to be the chief selling point.
And despite the downturn in global equity markets most of Hua Hong's comparables have held up relatively well over the past few weeks.
Shares in SMIC have risen about 30% year-to-date. Having hit a year-to-date high of US$5.32 in mid-February, the stock traded down until mid-June before embarking on a new upswing.
Over the last couple of days, however, this has shown signs of faltering, with the stock closing down 0.2% on Thursday at $5.
But Hua Hong's main Taiwanese comparable Vanguard International Semiconductor retains momentum. The stock has also climbed about 31% so far this year and closed Thursday at NT$46.30, up 0.65% on the day.
At this level, it is currently valued at 2.8 times its 2015 book value in line with its parent Taiwan Semiconductor Manufacturing Company, which is up 14.6% year-to-date.
Smart devices to power 200mm sector
Together TSMC and Vanguard form an entire industry chain, with Vanguard concentrating on the same 200mm low-end wafers as Hua Hong while its parent TSMC focuses on the more advanced 300mm processes. These wafers are used in the fabrication of integrated circuits, or microchips.
SMIC has tried to replicate the entire industry chain as well but has never been able to chip away at TSMC's dominant position in 300mm wafers. Its current production capacity of 200mm wafers stands at 131,000 per month compared with Hua Hong's 124,000.
Vanguard produces 167,000 wafers per month, but its product mix has little overlap with Hua Hong.
The Chinese foundry derives 33% of its sales from embedded non-volatile memory chips in devices like remote controllers and smart meters. Its Taiwanese counterpart makes 36% of its sales from chips in power management and logic products such as Bluetooth, GPS and finger printing.
Analysts say very little capacity has been added over the past four years, but this is now starting to change. Proceeds from Hua Hong's IPO are being used to expand capacity by a further 40,000 wafers per month over the next 12 to 18 months. Vanguard is also expanding capacity by 30,000 wafers per month.
Syndicate analysts also forecast that Hua Hong's average selling prices will rise at a compound annual growth rate of 5% in 2015 and 2016.
These two factors should help the company to maintain its gross margins around the 28.5% level it recorded at the end of June. This compares to gross margins of 21.5% at the end of 2013.
Revenues and profits are both on a rising trend. For the first six months of this year, revenues came in at $324.5 million, up 15.1% year-on-year. Net profits, meanwhile, stood at $44.69 million, up 47% on the same period last year.
Hua Hong's prospectus contains an industry report by IBS, which forecasts a CAGR of 7.4% in the overall foundry market between 2013 and 2020. Total revenues are expected to reach $69.3 million by the end of that year.
But aggregate sales in the 200mm sector are expected to remain flat over the same period, standing at $14.4 billion in 2020, the same level they were in 2013. IBS also predicts a small decline in average selling prices.
This gloomy outlook is likely to constitute one of the chief risk factors for the deal, although IBS points out that the Chinese foundries are in a strong position to take market share. This is because their main client base constitutes domestic fabless clients producing smart devices for products based on the internet of things such as smart fridges and TV's.
As a result, IBS predicts that the Chinese 200mm foundry market will expand by a CAGR of 5.2%, with revenues growing from $3.5 billion in 2013 to $5 billion by 2020.
It also concludes that the lower spec foundries have a more competitive cost structure than their cutting edge counterparts because they are using re-conditioned factories, which are fully depreciated. Average selling prices are also less volatile because their products have a long shelf life.
