Zhongwang targets at least $1.2 billion from IPO

China Zhongwang Holdings has set the price range for its initial public offering at a level that will allow it to raise between HK$9.52 billion and HK$12.32 billion ($1.2 billion to $1.6 billion) and claim the title as the largest IPO globally this year.

While ambitious at first glance, the size is less intimidating when considering that the Chinese manufacturer of aluminium extrusion products was largely immune to the global economic downturn in 2008 and is currently a direct beneficiary of the government's aggressive build-out and spending plans for the railway sector and the country's Rmb4 trillion ($585 billion) stimulus package.

Investors attending the company's lunch briefing at the Four Seasons hotel in Hong Kong yesterday, said they were encouraged by the company's focus on the transport industry and its leading position in that part of the Chinese market. They also welcomed the fact that the company had resisted jacking up the valuation too much compared with its closest comparable, Singapore-listed Jilin Midas, even though Zhongwang's much larger scale, both in terms of output and revenues, arguably warrants a premium.

Also speaking for a successful offering is the fact that many fund managers are sitting on significant pools of cash right now that they need to invest. The sheer size of the deal should ensure that Zhongwang is a liquid stock -- a feature which has become increasingly important to investors since the start of the financial crisis as they want to make sure they can get out quickly should they wish.

According to sources, the company and its three bookrunners, Citic Securities, J.P. Morgan and UBS, have already lined up a number of anchor investors to help drive the demand. The total amount committed by these names, which are all financial investors, hasn't been revealed and they will not be bound by a lock-up agreement since the volatile market environment means no investor is willing to give up the ability to sell in case of another severe downturn. However, their support will at least have taken the company part of the way towards filling the book before it started the official marketing process yesterday.

The shares will be offered in a range between HK$6.80 and HK$8.80, which at the upper end values the company at 13.3 to 13.6 times its projected 2009 earnings, according to the forecasts of UBS and J.P. Morgan. This puts the listing candidate at a slight premium to Midas, which is currently trading just below 11 times its forecast 2009 earnings, but at a significant discount to downstream customers such as China South Locomotive and Rolling Stock, China Railway Group and China Railway Construction, which are driven by the same macro trends. These stocks are trading at 2009 price-to-earnings ratios of 16 to 20 times.

At the bottom end of the price range, Zongwang is valued at 10.2 to 10.4 times projected 2009 earnings.

The company, which is based in the Liaoning province in northeast China, posted a 124% rise in net profit to Rmb1.9 billion in 2008 on a 24% increase in revenues, thanks to an improvement in profit margins resulting from a continued shift in its product mix from construction products to moulded industrial products, such as railway carriages, light trucks, automobiles, aircraft and power transmitters, which are more customised, have higher entry barriers, and are generating much faster revenue growth. According to syndicate research, the net profit is expected to be at least Rmb3 billion in 2009, which implies 58% growth versus last year.

Zhongwang will sell 25.9% of the company, in the form of 1.4 billion new shares, plus a 15% overallotment option. As is typical for Hong Kong, 10% of the base deal will be earmarked for Hong Kong retail investors, while the rest will be offered to institutional accounts. There will also be normal clawback triggers that may increase the retail tranche to up to 50% in case of very heavy demand from retail investors.

Immediately following the IPO, before a potential exercise of the overallotment option, the company's founding chairman, Liu Zhongtian, will own the remaining 74.1%. However, he may have to give up some of that to private equity firm Olympus Capital who bought $100 million worth of Zhongwang exchangeable notes in August last year, which can be exchanged into shares held by Liu starting from six months after the listing. Should Olympus decide to exchange the shares as soon as it is allowed to, it will pay 80% of the IPO price per share, although the exchange price will fall on each anniversary of the note issuance. After three years, the exchange price will have dropped to 45.8% of the offer price.

The chairman's foresight in shifting the company's focus to industrial products a few years ago allowed Zhongwang to continue to thrive even as China's real estate sector took a severe beating last year. About 70% of all aluminium extrusion products made in China are still targeted at the construction industry, however, and while other companies are now looking to follow Zhongwang's lead, the customised machinery needed for products targeted at the industrial sector means that Zhongwang is about three years ahead of the competition, the management told investors yesterday.

In 2006 some 27% of its revenues came from products targeted at the industrial sector, but by last year this had increased to 55%. Analysts expect this development to continue and project more than 90% of the top-line income will come from the industrial segment by 2011. Among the key opportunities over the next few years, according to the management, is the build-out of metro and light railway lines in numerous Chinese cities.

According to the preliminary listing document, the company plans to use 35% of the IPO proceeds, or about $420 million based on the bottom end of the price range, to expand its production capacity and to continue to penetrate the industrial market, particularly in the transport sector. It may achieve that by selectively acquiring other aluminium extrusion products manufacturers. Zhongwang has a current production capacity of 535,000 tonnes, which makes it the largest aluminium extrusion company in Asia and the third largest in the world behind Sweden's Sapa AB and Norway's Norsk Hydro. It is planning to increase its capacity to 800,000 tonnes by 2010, which should help increase its market share to 10% from 7% in 2007, syndicate analysts say.

Another 35% will be spent on manufacturing equipment and facilities for the production of down-stream value-added industrial aluminium extrusion products that will expand the current product offering and enhance the company's competitiveness. Some 15% will be used to repay existing debts due in the next 12 months and 5% to enhance its research and development activities and facilities. The remaining 10% will be for working capital.

The institutional bookbuilding will last for about a week-and-a-half. The Hong Kong public offering will launch on April 24 and the retail and institutional tranches will both close on April 29. The shares are due to start trading on May 8.

Zhongwang will be the largest IPO this year after Mead Johnson Nutrition's $828 million US offering in February and will dwarf the two largest IPOs in Hong Kong year-to-date -- Real Gold Mining and Silver Base, which raised just over $130 million apiece. In fact, Hong Kong hasn't seen a listing of this size since China Railway Construction Corp raised $2.5 billion from the H-share portion of its dual-listing in March 2008.