View from China: IPO - CNOOCÆs second but more realistic try

That the IPO of CNOOC Ltd [883], the Hong Kong-incorporated subsidiary of China’s third largest state-owned oil giant China National Offshore Oil Corp, has got off the ground 17 months after its first attempt failed, isn’t simply because it’s always easier the second time around, but has more to do with the company settling with its bankers a more realistic valuation befitting of current market sentiment.

StockHouse Logo At HK$6.01 ($0.77) a share, CNOOC raised about HK$7.98 billion in net proceeds, a more modest amount than the HK$19.4 billion it had aimed for in its earlier attempt that collapsed in October 1999. The IPO - of 1.64b shares or 20.5% of the enlarged issued share capital - is still dwarfed by last year’s share sales at two other Chinese oil giants, PetroChina [857] and China Petroleum and Chemical Co (Sinopec) [386], which raised HK$22.39 billion and HK$31 billion, respectively. CNOOC estimates that net proceeds from the issue would reach approximately $1.03 billion, of which $834.1 million would be used for capital expenditure and $200 million for retirement benefit payments to its parent company's employees.

As a Chinese oil company comparable to PetroChina and Sinopec, CNOOC looks a more attractive bet, as it is a smaller and younger operation – created from scratch in 1982 - that essentially carries little historical social burden. It has a skeleton workforce of 1000, compared with half a million each for PetroChina and Sinopec.

As a Chinese oil company comparable to PetroChina and Sinopec, CNOOC looks a more attractive bet, as it is a smaller and younger operation - created from scratch in 1982 - that essentially carries little historical social burden.

Compared with PetroChina and Sinopec, CNOOC has come to the market at a higher valuation, of about five times estimated FY2000 net profit of RMB10.2 billion ($1.23 billion), which some analysts have argued is unrealistic, given last year’s exceptionally high oil prices. Oil prices have softened from last year’s record levels and the benchmark Brent crude futures have been recently quoted at $27 per barrel. To offset this, CNOOC has promised to deliver more from cost-control measures and on the development and production fronts. The Company said its lifting costs - the amount it takes to bring a barrel of oil out of the ground - averaged $4.08 per barrel in the first nine months of FY2000 versus $4.70 for Sinopec, according to some analysts’ estimates.

Fund managers are also skeptical about how CNOOC will raise more funds to meet its growing annual capital expenditure needs (this will include production and exploration costs), forecast by the company to be about HK$8.04 billion for this year, HK$12.7 billion for 2002 and HK$14.6 billion for 2003.

While the response to CNOOC’s floatation has been no less enthusiastic than those received by Sinopec and PetroChina, overall market sentiment for Chinese companies has been one of heightened caution, despite a 23% gain in the Hang Seng China Enterprise Index since PetroChina listed on 7 April 2000.

Sinopec, for instance, has lost almost 20% in less than six months since its IPO last October. Investor wariness has grown over poor corporate governance and information disclosure, as well as doubts that management will serve foreign shareholders’ interests, even though Beijing has ordered stricter disclosure standards in recent weeks. Yet, the bigger issue is the murkiness of changing Chinese economic and political policies and their impact, which are chipping away foreign investor confidence.

Beijing has given CNOOC, which accounts for 90% of China’s offshore oil production, written endorsement of its exclusive right to enter into production-sharing contracts with foreign oil firms on offshore finds, and concern is mounting that such rights will be extended to other Chinese oil companies on the nation’s WTO admission to help them raise competitiveness. CNOOC is currently participating in 30 such contracts, under which it has the right to acquire, at no cost, up to a 51% participating interest in any successful discovery offshore made by foreign partners, including Agip SpA, BP Amoco PLC [L.BP], Burlington Resource Inc, Chevron Corp [CHV], Devon Energy Corp [DVN], Kerr-McGee Corp [KMG], Newfield Exploration Co [NFX], Phillips Petroleum Corp, Royal Dutch/Shell Group [RD] and Texaco Inc [TX].

An estimated 66% of the reserves haven't been developed, which means it can pump oil and gas for 20 years - without discovering a fresh field - before it runs out of fuel.

Through either wholly-owned ventures or contracts with foreign partners, CNOOC has oil reserves of 1.3 billion barrels. Its oil and natural gas fields lie in three areas: Bohai Bay, in northern China; the East China Sea, off the coast of Shanghai; and the South China Sea, near Hong Kong. An estimated 66% of the reserves haven’t been developed, which means it can pump oil and gas for 20 years - without discovering a fresh field - before it runs out of fuel.

Shell Eastern Petroleum Ltd, a unit of Royal Dutch/Shell Group, has pledged to commit to $200 million to $300 million worth of CNOOC’s issue, half of which it must hold for one year.

The IPO is also offered in the US in the form of American Depository Shares (ADS) at $15.40 a piece. Each ADS comprises 20 Hong Kong shares.