Yunnan’s largest wastewater treatment and reclaimed water supplier opened the order books for a HK$1.3 billion to HK$1.6 billion ($171 million to $205 million) Hong Kong initial public offering on Friday, hoping to capitalise on China’s efforts to dramatically improve its water management over the next four years.
The government has prioritised the industry and strong growth appears to be a given, although companies are at different stages in transitioning to the public private partnership (PPP) model the governments wants all future projects to be run on.
Market leader, Beijing Enterprises Water, has already moved strongly in the direction of an asset light model, winning Rmb35 billion ($5.08 billion) in PPP projects during 2016. By 2020, it hopes to have cumulative contracts of Rmb300 billion compared to self-owned assets of Rmb77 billion.
It sets the benchmark for state-owned operator Kunming Dianchi, which currently has a portfolio of 29 projects in operation, of which TOO (transfer-own-operate) projects account for 15, TOT (transfer-operate-transfer) 13 and BOT (build-operate-transfer) one.
Based on Friday’s HK$5.83 close, Beijing Enterprises Water was trading on a 2017 p/e multiple of 13.98 times consensus 2017 forecast earnings and 3.1 times forward price book.
Kunming Dianchi Water Treatment's 339.4 million share deal is being pitched at 10.9 to 13 times 2017 forecast earnings according to Haitong research and 1 to 1.2 times price to 2017 book. This means its IPO is being pitched at a 22% to 7.2% discount to Beijing Enterprises Water.
The syndicate forecasts that net profits will rise by 18.7% between 2016 and 2017 from $40.02 million to $47.5 million.
A second comparable, which has a similar market capitalisation to Kunming Dianchi, is private sector operator Kangda International. It is also transitioning to a PPP model and acquired three new projects on this basis during the second half of 2016 according to Zhongtai International research.
The brokerage estimates 20.8% 2017 net profit growth from Rmb382 million ($55.45 million) to Rmb464 million ($67 million). The stock is trading at 9.3 times consensus 2017 earnings based on Friday’s HK$2.13 close.
Year-to-date the stock is up 5.45%, compared to Beijing Enterprises Water’s 12.98% rise and an 11.53% jump by the Hang Seng China Enterprises Index.
Further afield, international comparables such as France’s Veolia (which derived 12% of 2016 revenues from China) is trading at 15.6 times 2017 earnings.
Dividend yield
One of the big selling points for Kunming Dianchi’s deal is its dividend yield. It has committed to pay out a higher-than-industry average dividend over the next two financial years and has said it hopes to continue longer than this.
Its 50% payout ratio equates to a yield of 3.8% to 4.6% according to syndicate forecasts compared to Beijing Water’s current 2.1% yield based on a 37.6% pay out ratio and Kangda International’s 0.89% yield.
In 2016, the company accounted for 45.1% of Yunnan’s designated wastewater treatment capacity, or 1.6 million cubic metres per day. This is its largest revenue contributor on 83.7% in 2016.
Second is running water supply, which accounted for 4.1% of 2016 revenue and 56,000 cubic metres of water per day.
In addition to its 26 projects in operation, it also has two under construction and a further three under development, of which two are in Laos, where it hopes to expand further.
China is one of the world’s most water deficient countries relative to the size of its population, with total capacity of 168.4 million cubic metres per day. Wastewater capacity is expected to grow by a compound annual growth rate (CAGR) of 5.5% from 2015 to 2020. Yunnan is expected to grow faster still by 6.7% over the same period because it has a lower urbanisation ratio.
However, Global Water Intelligence (GWI) suggests that even though the Chinese government is prioritising development, it is still underplaying the extent of shortages. GWI estimates that roughly 30% of industrial wastewater is treated, compared to official estimates around the 70% mark.
Deal details
There are four cornerstones taking $96 million or roughly 50% of the base deal at the mid point of the range. They comprise: Yunnan Provincial Investment Holdings on $33 million; Kunming IDI on $30 million, Beijing Water Enterprise on $23 million and China Water Environment $10 million.
The cornerstones and company will be under a six-month lock up, while the controlling shareholder is subject to a one-year lock up.
Pre-greenshoe, the company is offering 33% of its enlarged share capital and there is a standard 90%/10% split between the institutional and retail offering. The greenshoe has a 91%/9% split between primary and secondary share.
IPO pricing is scheduled for March 29, with listing on April 6. Pre-shoe it will have a market capitalization of $518 million to $622 million pre greenshoe.
Use of proceeds is split between 35% to finance existing projects; 35% to expand future operations; 20% to re-pay bank borrowings and 10% to fund working capital.
Morgan Stanley is sole sponsor for the IPO with other bookrunners comprising CICC, Haitong International, Zhongtai International, Huatai Financial, GF CCBI, BOCI, CMB International, Guotai Junan and Everbright Securities.
