Initially there had been some concern that the Territory's equity markets would be severely tested by the prospect of two large headline deals competing for investors' attention. Both transactions are scheduled to raise over $2 billion and many bankers were baffled as to why Sinopec would choose to go head to head with the Hong Kong government's benchmark privatization and all the attendant publicity that will surround it.
Yet, despite the fact that Sinopec held its analysts meeting last Sunday and MTR Corp will hold a similar meeting today (Friday), the former is now planning to begin roadshows during the last week of September as MTR Corp prices. The blackout period for analysts will begin on September 11.
With Morgan Stanley Dean Witter and China International Capital Corp (CICC) as joint bookrunners, Sinopec is set to raise $2.5 billion to $3 billion and will in many respects mirror its most comparable benchmark Petrochina, which raised $2.89 billion in April. In one crucial respect, however, it looks likely to differ markedly. Where Petrochina and indeed, its predecessor China National Offshore Oil Corp (CNOOC) had difficult passages through the primary markets, Sinopec is shaping up to be relatively smooth.
Many believe that the deal will ride on a wave of upward momentum created both by China Unicom's successful flotation in June and the strong secondary trading performance of Petrochina itself. The latter has wrong-footed even its most ardent critics. Having been priced at HK$1.28 and $16.44 per ADS, the company is, for example, now being quoted at HK$1.85 and $23.5.
As one London-based oil analyst puts it, "I'm not quite sure why anyone should be surprised by this, but they definitely have been. I'm certainly not saying anything different about the sector now than I was at the time Petrochina listed."
Much of the recent price upswing has been attributed to increasingly positive sentiment towards China's macro picture. "There is a lot of money buying China at the moment," says one banker, "and Petrochina is the best proxy of all on GDP growth and the underlying economic restructuring story."
Having grown by 8.2% over the first half of the year on the back of increased export growth, the country, according to economists, is likely to average 7.8% growth by year end, up from 7.1% last year. "The figures speak for themselves," the banker adds. "Primary industries such as agriculture make up only 18.4% of GDP, while secondary industries like oil account for 46%. The petrochemicals sector alone last year accounted for 40% of all profits from the industrial sector."
Similar to Petrochina, Sinopec, which ranks as the country's second largest oil company and its largest refiner, is also likely to have a strong anchor from a strategic stake by BP Amoco. The company took $1 billion of Petrochina and is strongly rumoured to be considering taking the same amount in Sinopec. So too, index funds should eat up a further $1 billion, making the deal far more digestible for the general market than it appears at first sight.
In terms of valuation, most analysts view Petrochina and Sinopec on a par with each other. Although the former is often talked of in terms of its exploration and production (E&P) capabilities and the latter in terms of its refining operations, the fact remains that there is only a percentage point or two difference between the two.
Says one Shanghai-based analyst, "Sinopec controls 59% of China's refining market and 42% of its onshore oil exploration and production. Petrochina controls 58% of all onshore oil production and 41% of its refining capabilities. Both of these companies are fully integrated upstream and downstream entities."
The two companies date back to 1998 when the government undertook a massive restructuring of the Mainland's oil market which effectively separated the regulator from the industry. China National Petrochemical Corp (CNPC), which owns Petrochina, was assigned western and northeastern onshore and shallow water areas of China, while Sinopec was assigned southern and eastern onshore and shallow water areas. CNOOC, by contrast, retained offshore rights in water depths greater than 30 metres.
Where revenue is concerned, analysts say that Petrochina is likely to report a loss on its refining operations over the first half of the year. "E&P will account for almost all the profit and its chemicals operations have also turned the corner," says one. "But refining has performed poorly because the government wouldn't allow high crude oil prices to be passed through into fuel prices until May."
In global markets, the price of a barrel still remains over 50% higher than this time last year, despite the fact that prices have dropped from a $32 per barrel high in mid-June to $25 currently. In China, crude oil prices have been pegged to the outside world since the second half of 1998, but only really moved exactly in line with global prices since the beginning of this year.
"One of the greatest challenges the Chinese oil industry faces is that it is has not traditionally worked with real oil prices," says one observer. "Productivity costs are also high and the whole sector is vastly overstaffed. Petrochina employs 500,000 people to Shell's 100,000 who are, furthermore, spread right across the globe."
"But," he continues, "the petrochemicals sector is spearheading the country's restructuring programme. I was vastly impressed by the change in management attitude at Petrochina when company officials last came to visit."
Petrochina's strong secondary market performance has also meant that the company is now trading flat to its DCF (Discounted Cash Flow) valuation. On a firm value to EBITDA ratio of 4.7 times projected 2000 earnings, it is also trading in line with the emerging markets sector worldwide.
Analysts conclude that historically, emerging market oil plays have generally traded at a discount to their counterparts in the developed world. Where, for example, the super majors such as BP and Shell are trading at 2001 EBITDA multiples in the low teens, smaller integrated oil companies such as Conoco and Occidental trade at around 5.5 times and emerging market oil companies like Lukoil at around 4.5 times.
"As a whole, the emerging markets sector trades at about 5 times, but this ratio is skewed by Petrobras in Brazil which pulls up the whole sector," says one banker. "Because oil is such a capital intensive business, companies located in the developing world should always trade at some kind of discount because the cost of capital will be higher."
