Big Chinese IPO Faces Tough Sale

By SHULI REN | MORE ARTICLES BY AUTHOR

A leading construction-machinery maker may not have timed the Hong Kong market quite right. Investors with feet stuck in concrete?

•  Markets

Chinese construction-machinery maker Sany Heavy Industry is seeking approval from the Hong Kong Stock Exchange this month for an initial public offering of up to $3.5 billion, one of the biggest deals this year. While Sany has a successful track record and ambitious expansion plans in the U.S. and elsewhere, the IPO's timing is not the best—as a major competitor can attest.

Sany (ticker: 600031.China) has an enviable business position. Over half of its revenue came from concrete machines in 2010, where it and rival Changsha Zoomlion Heavy Industry Science & Technology Development (1157.Hong Kong) enjoy a duopoly. Together, they account for more than 85% of the liquid-concrete pump market, a dominance they're unlikely to lose any time soon. Local rivals do not have the R&D budgets to offer the complete product line-ups that generally appeal to Chinese customers. Foreign firms, meanwhile, do not have strong distribution channels. As a result, the twosome have enjoyed high gross margins, with Sany slightly ahead at 41.7%, to Zoomlion's 35.5%.

While construction pumps are the cash cow, excavators are Sany's growth engine. It has successfully grabbed market share from foreign competitors, rising from 2.7% in 2007 to 10.7% this year, just behind leaders Komatsu (6301.Japan) and Hyundai Heavy Industries (9540.Korea)—without ceding attractive pricing. According to a CLSA report, Sany's 20- to 22-tonne excavator is priced midway between Komatsu's and Hyundai's. Gross margin for the segment was 30.3% in 2010. As to Sany's crane-machinery segment, it was able to obtain a 29.5% gross margin in 2010 by leveraging up its R&D and focusing on crawler cranes, the most technology-intensive type.

Sany's Shenzhen-listed stock, known as A-shares, is not a good benchmark for the coming listing in Hong Kong for so-called H-shares. Shenzhen stocks are aimed at local Chinese buyers, while Hong Kong attracts foreign investors due to China's cross-border investment restrictions. In general, the foreign interest tends to make Hong Kong shares trade at a premium. Since its Hong Kong debut last December, for example, Zoomlion's H-shares have traded above their Shenzhen counterpart 85% of the time, with an average premium of 6.8%. Because of their duopoly and similar profit profiles, it's a better gauge of investor demand for Sany's offering. Indeed, Sany's A-shares track Zoomlion's well: there's a 93% correlation in the past three months.

Zoomlion's Hong Kong experience, however, has been bumpy. It sold 870 million shares at a split-adjusted 11.52 Hong Kong dollars (US$1.48), at the low end of the preliminary, indicative price range. The offer amounted to a near-14% discount to its Shenzhen price. The shares jumped to their high this April at HK$17.46, a 51.6% premium over the offer price. A month ago, they traded at HK$15.46. But global equity market jitters have since sent the shares back into the dumps: They now trade close to the public opening price last December, and at an 8.3% discount to the Shenzhen shares, despite analysts' upward adjustments in earnings.

With Zoomlion's shares now trading at an all-time low price-to-earnings multiple, Hong Kong investors are sending a very clear message: They're fatigued from China's monetary tightening and property-price cooling measures. They want to invest in its construction sector when the dust settles. Sany might be better off waiting a while to raise new money, since investors don't seem in any rush to provide it. 

Strong Week

Led by India's surge, Asian markets posted across-the-board gains.

SHULI REN is a Hong Kong-based columnist with Dow Jones Investment Banker, covering Asia.