Molybdenum producer markets growth story to IPO investors

The name doesn’t exactly role off the tongue, but if investors can get past that small problem, they will find that China Molybdenum, or China Moly for short, is actually quite a simple story – a mining company with one mine that produces a specialty metal which is in high demand by China’s growing stainless steel industry.

And the one mine isn’t just any old mine, but one of the largest pure molybdenum mines in the world with 498,000 tonnes of reserves. Much of the global supply of molybdenum is otherwise derived as a byproduct of copper processing, making companies with a primary focus on this metal something of a rarity.

The same mine also contains 506,000 tonnes of tungsten reserves, making China Moly the second largest owner of tungsten reserves in the world. This metal, which is a byproduct from molybdenum processing, currently accounts for less than 1% of China Moly’s revenues but will become an increasingly important growth driver once the company completes the construction of its own tungsten recovery facilities by early 2008, sources say.

The company will also use the IPO proceeds to increase both the ore output from its mine and the processing capacity of various molybdenum products further down the value chain. Consequently it is being marketed as a growth story with a potential for 44% growth in net profit this year and 15% in 2008, according to a syndicate research report. This comes on top of 31% profit growth last year and 319% in 2005.

“This company has the necessary scale in its molybdenum production and it is in the right place with demand in China increasing rapidly,” one observer says.

“There is also an M&A theme as the company is looking to buy up mines and mining rights amid further industry consolidation,” adds another.

Molybdenum is used primarily to harden various forms of steel, making it more resistant to corrosion and improving its strength at high temperatures. Steel mixed with molybdenum has a variety of applications within the construction, shipbuilding, auto, defense and oil industries among others. What makes it especially valuable though, is the fact that it has few substitutes.

According to a Roskill Molybdenum Economics report, quoted in the pre-deal research, China’s consumption of molybdenum grew at a CAGR of 17% between 2000 and 2005 which was 7.7 times the growth rate in the US, 5.3 times that in Western Europe and 3.5 times the growth rate in Japan.

Tungsten too is used as a steel alloy and is a metal which should be familiar to Hong Kong investors after Hunan Nonferrous Metals, one of China’s leading integrated producers of tungsten, completed its own IPO in March last year. Even those who didn’t pay much attention to the IPO will be aware of HNF’s spectacular 73% gain on its first day of trading. Since then the share price has continued to head higher and even after some volatility over the past month it closed at HK$5.06 on Friday – more than three times its IPO price of HK$1.65.

No doubt, investors will be hoping for similar medium-term gains for China Moly, which is currently pre-marketing an initial public offering of more than $500 million through Morgan Stanley and UBS. Notably, Morgan Stanley was also one of the bookrunners for HNF’s IPO together with BOC International.

The molybdenum producer has already attracted the attention of a number of tycoons and corporate investors. According to sources, the company plans to sell around $150 million worth of shares to seven or eight such cornerstone investors who in return for a guaranteed allocation will commit to a 12-month lockup.

The final list of cornerstone investors has yet to be agreed upon, but sources say they will include many of the usual players who tend to participate in Hong Kong listings of large Mainland companies, including China Life Insurance, Henderson Land Development chairman Lee Shau Kee, Dickson Concepts chairman Dickson Poon, and either Temasek or GIC, both of which are investment companies set up by the Singapore government.

China Moly is selling 22.7% of its issued share capital in the form of 1.08 billion new H-shares. There will also be a greenshoe of between 10% and 15%, with the final size to be determined before the launch of the formal institutional roadshow on April 9. The price range will also be set at that same time.

As with all H-share IPOs, the company will also need to transfer shares equivalent of 10% of the new share issue to the National Social Security Fund. This transaction will be done outside the actual share offer but the shares will count towards the free-float, bringing it up to the required 25%. The deal will have the usual 90-10 split between institutional and retail investors with a standard clawback mechanism.

The eventual IPO price is expected to value the company somewhere in between fellow specialty metals producer HNF, which currently trades at about 15.5 times projected 2007 earnings, and base metals producers like Jiangxi Copper and Aluminum Corporation of China (Chalco), which tend to trade at an average forward P/E multiple of about eight times.

Base metals aren’t in the same short supply as specialty metals, however, and the irreplaceable nature of both molybdenum and tungsten in steel production suggest they should trade at a premium to the former group, one observer notes.

HNF has a larger total tungsten reserves than China Moly at 525,000 tonnes, but when taking account of the fact that it only owns 79% of its main mine, China Moly’s attributable reserve is actually 16% greater than HNF’s 436,000 tonnes. China Moly’s estimated profit is also about two times that of its listed rival. Balancing out that somewhat, HNF’s tungsten business is more developed than China Moly’s which was started only in the past year. HNF also has exposure to lead and zinc, making it slightly more diversified.

China Moly could potentially also be compared to Toronto-listed which is the only pure molybdenum producer that is publicly listed and currently fetches a 2007 P/E multiple of about 8.3 times. Here too, analysts argued that China Moly deserves a premium, because of its four times larger reserves (which are also of higher grade), its longer mine life at 46 years versus less than 10 years, and its lower cash costs.

Using a valuation based on enterprise value to molybdenum reserves, a syndicate research report estimates Blue Pearl’s valuation at $4.56 per pound, compared with a proposed range of only $2.48 to $3.16/lb for China Moly (due to its larger reserves), which could result in some investors viewing the latter as a value play in comparison with its Canadian peer.

At the end of last year, China Moly’s Sandaozhuang mine processed 9.9 million tonnes of ore per annum at its six processing plants, which was double its 2004 output. While this is expected to remain constant over the next two years, the company is forecast to raise its extraction of molybdenum concentrate to about 28,000 tonnes this year and 33,000 tonnes in 2008 from 21,410 tonnes in 2006, representing a three-year CAGR of 49%.

Starting from this year, the company will sell none of its molybdenum ore but will use it internally to produce other products down the value chain, such as molybdenum oxide and ferromolybdenum.

Last year, the company derived about 40% of its revenues from ferromolybdenum, which is its most refined product and about 25% each from molybdenum oxide and molybdenum concentrate (the rest came from its tungsten business, the selling of ore and “other” things).

Two years down the line, ferromolybdenum’s contribution is expected to have increased to 55%, while molybdenum oxide will fall to 9% and molybdenum concentrate to 19%. The sale of tungsten concentrate should pick up to 4%-5% of the total from less than 1% now when it sends all the leftovers from its molybdenum processing to a 40% owned-associate that extracts the tungsten, the analysts project.

“We believe China Moly is evolving from an upstream material producer into a fully integrated molybdenum product producer,” one report notes, and adds: “increasing downstream processing helps to create a more stable profit profile.”

Like other mining and metals companies, China Moly’s profits are highly dependant on the price of the metal it sells and as seen in recent years this can fluctuate substantially. Molybdenum prices multiplied to an average of $33.90/lb in 2005 (after peaking at above $40/lb) from $5/lb in 2003 as the global roasting capacity was unable to match the demand from the steel industry. The forced closure of small, polluting mines in China in 2005 added further to the supply pressure.

Last year the price came down to an average of $25.11/lb, and in the first quarter this year it has hovered at $25-30/lb. The pre-deal research projects a further drop of the average price to $22.5/lb this year and $20/lb in 2008, but notes that China Moly’s cash costs of only $3-4/lb should lead to strong profits and cash flow nevertheless.

The price development at the start of this year also suggest that the price forecast may be too conservative.

The final price on the China Moly IPO is expected to be fixed around April 18-19, while the trading debut is currently scheduled for the middle of the week of April 23.