The leading company in the only sector where Asia has complete world dominance began pre-marketing its IPO this Monday via joint bookrunners LG Securities, Morgan Stanley and UBS. TFT-LCD producer LG Philips LCD is hoping to become the first company to secure a simultaneous listing on the Korean and New York stock exchanges.
LGP is not only widely acknowledged as one of Asia's premier companies, but is also a global giant thanks to the increasing use of flat panels in electronic goods such as telephones, computers and televisions. If market conditions are conducive, it may raise more than $1.8 billion, beating SMIC as the year's largest Asian IPO and the world's largest tech IPO pre Google. If market conditions are not receptive, it may be remembered as the company, which failed to shine because it mis-timed its IPO by just a couple of months.
Timing an equity deal for a TFT-LCD producer is never easy and particularly one like LGP, which has been constrained by a large number of regulatory hoops. Industry cycles have also been described as "DRAM at warp speed," meaning judicious timing is more a matter of luck than skill.
Under Korean regulations, LGP must float a minimum 10% of its issued share capital. So far the company has said it will raise at least $1 billion from a new share issue.
The company's two founders, LG Electronics and Koninklijke (Royal) Philips Electronics have previously said they would also like to raise a further Won800 billion ($688 million) from the sale of secondary shares. The two established LGP in 1999 and currently own 50% each.
However, the secondary sale may now be cut back because valuations have significantly compressed over the previous couple of months. Specialists say that while LG Electronics would like to book some proceeds, it is unwilling to let its stake drop below Philips, which is less inclined to sell in current market conditions.
The split between the percentage listed in Seoul and New York has also not yet been fixed, although specialists say the former is unlikely to be more than 25% of the total and could be considerably less. The Korean listing is complicated by the fact that it needs to be hard underwritten and typically most Korean IPOs are priced at a 30% discount to fair value to ensure they perform in the secondary market and underwriters do not lose money.
In this instance, specialists say the deal will be run via a single global book and while the local offering will be hard underwritten, pricing will be driven by international demand rather than the pre-fixed pricing formulas typically used in Korea.
Alongside the leads, co-leads in the international tranche are ABN AMRO, JPMorgan and Lehman Brothers, with CLSA as co-manager. For the domestic IPO, Dongwon Securities will join the three bookrunners.
Under the current timetable, the deal will pre-market for two weeks, then roadshow for two weeks before pricing during the week beginning July 11.
Valuation
Syndicate banks have assigned an array of fair value assumptions for the company, which consequently span a very wide range of about $11 billion to $17 billion. At the top end of this range, the potential market capitalization of LGP would almost equal the entire market capitalization of Taiwan's five listed TFT producers - AU Optronics, Chi Mei Optoelectronics, Hannstar, Quanta Display and Chunghwa Picture Tubes. Together, the five currently total just over $18.5 billion.
Fund managers say LGP is being pre-marketed using three main valuation metrics: PE, EV/EBITDA and price to book. Where PE is concerned, the group is being pitched on a range of seven to eight times 2004 earnings, while the EV/EBITDA range is four to five times 2004 earnings and the price to book range two to three times 2004 earnings.
Again, however, the leads are encountering a number of problems. Under Korean regulations, they will need to pinpoint a more precise valuation and file a formal range at the beginning of next week before pre-marketing is completed. This will expose the deal to extended execution risk at a time when markets are extremely volatile and flexibility is paramount.
Setting a range, which generates momentum is not easy when the outstanding comparables are all on a downward bias. The main comparable is AU Optronics, the largest, listed pure TFT-LCD play, which has a dual Taiwan and New York listing.
Aside from the five Taiwanese producers, the only other TFT-LCD producer is Samsung Electronics. But specialists say few accounts are looking at it because it trades like a holding company and only 20% of its business is TFT-LCD related.
But using AUO as a comparable presents a number of difficulties, not least of which is the technical overhang of a prospective ADR issue. Nearly one month ago, the company filed for a 500 million share deal, which could have raised up to $900 million based on a then share price around the NT$66 mark.
Yesterday (Wednesday), AUO closed at NT$49.6, down 26% from its year-to-date high of NT$75.71 in mid-April. Tech specialists believe the company will refrain from raising money until the stock re-bounds, which they consider equally unlikely when investors know there is a double overhang from the ADR issue and LGP's IPO, which may cannibalise AUO's investor base.
At its height, AUO was trading on a price to book valuation of 2.5 to 2.8 times 2004 earnings depending on which analyst you speak to. Now the stock is trading between 1.7 and 2 times, a much lower valuation benchmark for LGP.
In deciding whether they want to buy LGP, investors face two key questions. Firstly, what point has the TFT-LCD cycle reached and which direction is it heading in? Secondly, what sort of premium should LGP trade above AUO?
Where the first question is concerned, there is currently very little consensus and as such many observers argue LGP could hardly have picked a worse time to do its IPO. In mid-April, producers were notching up record monthly sales volumes and record ASP's (Average Selling Prices). Analysts that had previously set price targets around the mid NT$60 mark for AUO were busy putting them up to just over NT$100.
Had LGP completed its IPO then, it would undoubtedly have been a runaway success.
Just one month later, however, and some houses were starting to tell clients to avoid the sector altogether. In a report published in mid-May Deutsche Bank said, "We recommend investors stay away from panel makers over the next quarter as earnings may be peaking in 2Q04."
Falling ASP's?
The downturn, when it came, was prompted by news that ASPs may start falling at a time when a lot of new capacity is scheduled to come on stream. Investors interpreted this as the top of the market, concluding that margins will drastically contract and second tier players will once again become unprofitable until the next industry cycle kicks in.
Just like the DRAM sector, TFT-LCD stocks tend to trade in line with projected ASP movements rather than analysts' forecasts and the whole sector fell. IDC, for example, forecasts that while panel shipments will increase from 127.8 million in 2004 to 177.5 million in 2005, sector revenue will fall from $37.1 billion to $36.3 billion.
Now many are questioning whether stocks have been oversold and too much fear has been priced into the market. "I think it has," says one non-syndicate ECM head. "If you think about it, global growth is pretty robust and demand for electronic products should be strong going forwards.
"The main problem is that I can see no catalyst to push these stocks higher before LGP completes its IPO. June and July are always dead months for electronic orders, so stronger demand is unlikely to feed through until September's figures."
And he goes on to add, "Investors are reacting in the just the same way they are to interest rate hikes. The prospect is more terrifying than the reality. A slight decline in ASP's would be no bad thing because it will re-ignite end user demand. Flat screen TV's, for example, are still too expensive to generate the kind of demand many had been hoping for."
But there are also those who believe ASP's will not fall as drastically as some fear because supply side constraints will remain. Initially the TFT-LCD cycle was underpinned by slowness ramping up 5G fabs because of teething troubles with the new technologies they employed. Lately, capacity increases have been held back because of component shortages, which some industry watchers see no signs of this easing. Glass, in particular, remains in short supply.
The most optimistic believe the whole TFT-industry is misunderstood particularly by domestic Taiwanese investors that can turn over the equivalent of AUO's entire $7.5 billion market capitalization in the space of a month. Specifically, they argue that the DRAM and TFT-LCD sectors have parted company and the latter should enjoy a much more prolonged cycle and stable trading pattern.
During the last industry downturn in 2002, a number of producers failed to make profits. During the next downturn, some argue that everyone will continue to make profits, because producers' product ranges have become so much greater and therefore more flexible - spanning 2" mobile phones to 40" TV screens.
In a previous interview with FinanceAsia, Chi Mei CFO Eddie Chen also explained why capacity expansion is very different in the TFT-LCD sector. "The jump from an 8" fab to a 12" fab means a massive increase in output for DRAM manufacturers because the geometries of the wafers get smaller," he comments. "We, on the other hand, are producing larger panels from bigger fabs, not smaller ones, so the growth in capacity is nowhere near the same."
But if one thing can be said with certainty it is that no industry participant is ever very certain about its financial forecasts. In 2003, AUO initially projected full year net profits of NT$2.6 billion ($77.61 million). It went on to make NT$15.7 billion ($468 million).
Not surprisingly syndicate research forecasts also embrace a very wide range of ASP assumptions that span drops of 0% to 15% in 2H04.
Premium to AUO
Fund managers say lead bankers are presenting LGP as a company, which operates in a completely different league to AUO. Historically, LGP has been the world's largest flat panel producer. It lost its crown to Samsung during the first quarter, but believes it will reclaim it again by the third when it starts to ramp up its first 6G fab.
At the end of the first quarter, Samsung had a 23.5% global market share, compared to 20.8% for LGP, 13.2% for AUO, 10% Chi Mei and 7.9% Chunghwa Picture Tubes.
By 2005, lead bankers have been arguing that LGP will have extended its lead over AUO and will be 70% to 90% bigger in capacity terms. They have also highlighted how it beats AUO on any efficiency metric and thanks to its faster 5G ramp up, now enjoys a 20% cost advantage over its smaller rival.
For example, in 2003, LGP recorded an ROE of about 42% compared to 18.6% for AUO. In 2004, syndicate forecasts predict ROE expansion to nearly 50% for LGP and 37% for AUO, equating to profits of $2.02 billion. In 2005, however, they believe both ROE figures will halve and AUO will hover close to its cost of equity.
"This company has 13 times the number of patents AUO has," says one specialist. "It doesn't have to pay out major license fees like AUO and it spends 50% more on its R&D."
One crucial difference between the Taiwanese TFT-LCD players and the Koreans is that the latter operate vertically integrated models where they seek to control all aspects of the supply chain. In Taiwan, by contrast, the flat panel industry grew from the PC outsourcing trend.
LGP supporters believe this difference will be keenly felt once the flat screen TV market really starts to gain traction and the Koreans can fully leverage their consumer electronics distribution expertise. In 2003, LGP had a 28% share of the TV market, compared to 16% for Samsung and 6% for AUO.
Currently about 15% of LGP's panel output serves the TV market. Some analysts believe it could climb over 30% by the end of 2005. Over the next 10 years it plans to spend up to Won25 trillion ($21 billion) in capex.
In considering where LGP should price in relation to AUO, some believe it should come at a premium of 15% to 30%. Others believe a Korea discount needs to be factored into the equation since most of the country's stocks trade below their regional peers.
All acknowledge that considerable investor education is required given that very little information about LGP has ever been publicly disclosed. The sector has consequently tended to be judged in relation to the performance of the listed Taiwanese comparables, which have difficult business mixes and corporate structures to the Koreans.
One aspect which may act in LGP's favour, however, is the attitude of global investors. Traditionally, AUO's ADR has traded in line with its domestic share price. Since March, a premium has opened up, reaching 23% at one point and currently standing at 14.75%.
"US investors seem to be waking up to the fact that this is a sector they need to own," says one tech specialist. "Over the past few months they have been buying rather than selling."
