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China Gas Valuation Tempts Richer Takeover Bid: Real M&A

Investors are betting that a takeover offer for China Gas Holdings Ltd., already the most expensive in the pipeline and gas distribution industries since the 2006 buyout boom, will need to get even richer to succeed.

China Gas, a one-time fashion retailer that delivers gas in the world’s second-largest economy, is trading 10 percent above the HK$3.50 a share bid from ENN Energy Holdings Ltd. and China Petroleum & Chemical Corp., known as Sinopec. That’s the most for any deal of more than $100 million in Asia’s developed markets, according to data compiled by Bloomberg. Including net debt, the HK$25.5-billion ($3.3 billion) offer values Hong Kong-based China Gas at 11.3 times earnings, the highest since 2006 for a cash acquisition of a pipeline or gas distributor.

While many traders are wagering ENN and Sinopec will raise their bid, CIMB Group Holdings Bhd. and Nomura Holdings Inc. are advising shareholders to sell China Gas. Boosting the offer would be a mistake for Sinopec with the purchase likely to add less than half a percent to its earnings, according to Sanford C. Bernstein & Co. Meanwhile, ENN is facing a downgrade to junk status over a potential increase in its debt from the deal.

“I am negative on this deal,” Alick Wong, a research analyst at Louis Capital Markets in Hong Kong who specializes in merger arbitrage, said in a telephone interview. “It’s too risky. If they are going to raise their offer, the increase may be small. If they don’t raise their offer, then the deal will collapse.”

China Gas fell 1.6 percent, its biggest decline in a week, to HK$3.79 today. ENN rose 0.2 percent to HK$26.15, while Sinopec fell 0.3 percent to HK$8.86.

Fashion Retailer

The offer price represents a “fair valuation” for China Gas, an external spokesman for the bidders wrote in an e-mailed response to questions. A spokesman for China Gas didn’t return calls seeking comment.

China Gas evolved out of a fashion retailer called Ltd., which was renamed Hai Xia Holdings Ltd. in 2001 and then China Gas the following year when it began to acquire natural-gas projects in China.

The company now sells gas to 6.6 million residential customers and about 42,000 industrial and commercial users, and owns 112 natural gas refilling stations, according to its results for the six months through September. In that period China Gas generated about 43 percent of its revenue from sales of piped natural gas, and another 39 percent from liquefied petroleum gas that is sold in canisters.

Highest Multiple

With China Gas’s market capitalization down 25 percent to HK$12.3 billion in the twelve months before its shares were halted on Dec. 7, ENN and Sinopec offered to pay HK$14.6 billion for 95 percent of the company, saying a combination would increase ENN’s share of the natural gas distribution market and allow Sinopec to “expand its businesses.” Sinopec already owns 5 percent of China Gas.

While a deal would give Sinopec increased market access, buying China Gas jointly with ENN, “will make it difficult to restructure the company and derive some of the cost savings that would be required to make this acquisition more attractive,” Neil Beveridge, a Hong Kong-based analyst at Sanford C. Bernstein, wrote in an e-mailed reply to questions. “At the current valuation, we see this as value dilutive.”

Including net debt, the HK$3.50 bid values China Gas at 11.3 times its earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg. That’s the highest multiple for any all-cash acquisition of a pipeline or gas distribution company worth more than $1 billion since a group led by Richard Kinder offered to buy Houston-based Kinder Morgan Inc. in May 2006 for 27.4 times Ebitda in a $27 billion deal, data compiled by Bloomberg show.

Credit Crisis

That takeover was completed during the 2005 to 2007 leveraged buyout spree, when about $1.6 trillion in LBOs were completed, according to Preqin Ltd., a London-based research firm. Dealmaking then ground to a halt as the collapse of subprime mortgages and Lehman Brothers Holdings Inc.’s 2008 bankruptcy froze credit markets and spurred the worst financial crisis since the Great Depression.

Excluding net debt, the offer from ENN and Sinopec valued China Gas at 24.5 times net income. That’s more expensive than every publicly traded utility network in Hong Kong with a market capitalization of more than $500 million except for Hong Kong & China Gas Co., data compiled by Bloomberg show. Those nine companies generated an average profit margin of 23 percent in the past year, compared with 5.3 percent for China Gas.

“China Gas’s fundamentals do not support such a high price,” said Shi Yan, a Shanghai-based analyst at UOB-Kay Hian Ltd. “A higher offer from ENN and Sinopec looks more and more unrealistic with the price at current levels.”

ENN, Sinopec

ENN, which supplies customers with fuel via a 17,000-kilometer gas pipeline network, will fund 55 percent of the deal, while Beijing-based Sinopec would finance the rest, the companies said. ENN, based in Hebei province in northern China, and Sinopec plan to leave 25 percent of China Gas in public investors’ hands to maintain its listing in Hong Kong, and may sell back some shares after the purchase to do so.

China Gas on Dec. 14 rebuffed the bid from ENN and Sinopec and last month said almost 4,000 employees signed letters opposing the offer. The workers are concerned the takeover may hurt the operations of the company and the development of the gas industry in China, according to a Feb. 3 filing to Hong Kong’s stock exchange.

Fortune Oil

The company’s shares closed above HK$3.50 on Dec. 20, and rose another 11 percent to reach a fifteen-month high of HK$3.88 on March 5. Purchases by China Gas’s largest shareholders, including former managing director Liu Ming Hui, who was removed from the company’s board last April after being detained by Shenzhen police the year before, have contributed to the recent surge in China Gas shares, according to Bank of China International Ltd. analyst Wang Pei.

Some speculators are betting on a higher price in part because of the buying by Liu and London-listed Fortune Oil Plc, which invests in Chinese infrastructure, according to CIMB analyst Mike Yip.

As of March 13, Liu and Fortune, and an entity controlled by a Fortune director, held a combined stake of about 14 percent in China Gas, up from about 10 percent at the start of 2012, according to filings with Hong Kong’s Securities and Futures Commission.

The parties, which have together bought more than 160 million shares of China Gas this year, haven’t publicly cited a reason for their purchases. Only one purchase, of 500,000 shares on Jan. 19, was for less than HK$3.50, the filings show.

Tee Kiam Poon, Fortune Oil’s chief executive officer, didn’t return calls to his office in Hong Kong. Calls and e-mails to China Gas’s Eric Leung outside of normal business hours requesting to speak with Liu weren’t immediately returned.

‘Price Comes Right’

“They want to increase the price,” said CIMB’s Yip. “If the price comes right they can tender their shares, if not they’ll stay the largest shareholders.”

Yip has an underperform rating and a HK$2.04 price estimate for China Gas, which he says reflects the dim prospects for its LPG business with the Chinese government championing sales of the safer and cleaner burning natural gas.

While ENN had 5.7 billion yuan ($899 million) in cash and equivalents at the end of June, its shares suffered a four-day, 14-percent slump after the bid as Moody’s Investors Services put the company’s debt on review for a downgrade to below investment grade. Moody’s cited the likelihood that the offer would “significantly increase” ENN’s debt position, while adding only a “minimal amount of cash flow.”

“Our fear is any increase in offer price will definitely mean higher gearing, and potential rights issues or placement of shares,” said Nicholas Yeo, the Hong Kong-based head of China and Hong Kong at Aberdeen Asset Management Plc, which sold its 14 million shares in ENN after news of the bid. Aberdeen oversees about $265 billion in assets globally.

‘No Discipline’

“Investors want to see discipline in pricing in all acquisitions,” Yeo said. “If there’s no discipline, then that’s going to be very negative for ENN.”

The acquisition requires approval from ENN’s shareholders, which will be difficult to get if the price is raised too high, according to Nomura Holdings.

“We advise investors to take profit” in China Gas, Nomura said in a Feb. 28 research note. It has a price estimate of HK$3.32 on China Gas, 14 percent below yesterday’s close.

Even if ENN can’t afford to pay more, Sinopec, with a market value of $102 billion, may be able to take a larger share of the bid, according to BOCI’s Wang.

“ENN may have to settle for a minority share in the sweetened offer since ENN cannot afford to raise its debt level too high,” said Wang, who has a price estimate of HK$3.42 on China Gas.


ENN plans to send shareholders details of the offer by March 31, a month later than the initial proposal indicated. On March 6, ENN’s Chairman Wang Yusuo told reporters in Beijing a higher bid was “impossible.”

The next day, ENN and Sinopec said Wang’s comments reflected his own opinion and the bidders weren’t bound by his words. China’s Ministry of Commerce has started to review the proposal for clearance under anti-monopoly laws, ENN and Sinopec said in a statement.

The risk for traders now is that the bid won’t be raised enough to spur China Gas’s shareholders into accepting, said UOB-Kay Hian’s Shi, who has a price estimate of HK$3.80 for the shares. A breakdown of the deal would “wipe out any gains investors have made” as the stock falls back to pre-deal levels, she said.

“There may be a chance for the offer to be sweetened up a bit, but the downside risk is too high,” Shi said.

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