China Railway Construction IPO On Track

The building and infrastructure company aims to raise as much as $5.3 billion from its dual A-share and H-share listing

China Railway Construction Corporation (CRCC) attracted a lot of interest when it kicked off the institutional roadshow for the H-share portion of its initial public offering in Hong Kong yesterday with about 350 investors showing up at a lunch to hear the management talk about strategy.

The company, which is primarily active within infrastructure construction, and last year featured on Fortune's list of the world's top 500 companies, aims to raise between HK$16.9 billion and HK$18.3 billion ($2.2 billion to $2.3 billion) from the H-share portion alone and up to Rmb22.3 billion ($3.1 billion) from its near-simultaneous A-share offering.

The combined size of up to $5.3 billion will make this the largest IPO in Asia so far this year, ahead of Reliance Power's $3 billion deal in mid-January.

The interest isn't surprising given that its two main Hong Kong-listed comparables—China Communications Construction Co (CCCC) and China Railway Group—have held up well during the market downturn in recent months, lifting investors' hopes that this will be another winner. Indeed, China's construction and infrastructure sector is expected to remain busy irrespective of whether there are more subprime related fall-outs in the global markets to come and CRCC also continues to accumulate construction orders from abroad. It is currently engaged in 137 overseas projects in 27 different countries. Only last week, it won the contracts for the construction of two railway lines in Libya with a total value of about $2.6 billion.

According to its own admission, the listing candidate has been involved in the construction of almost all railway lines in China since 1949 and is also the largest provider of highway construction services, with a specific focus on freeways, bridges and tunnels. Its flagship projects include: the Qinghai-Tibet railway line, which opened in 2006; the Wushaoling Tunnel, which was the longest tunnel in Asia when it was completed in 2006; and the ongoing construction of the Nanjing Yangtze River Tunnel, which will be the longest and widest tunnel under the Yangtze.

Still, the IPO will be a key test for the market. Hong Kong has yet to see its first listing of any significance this year after the volatile market conditions led to the withdrawal of four offerings just before pricing in January. A successful debut for this high-profile deal will be crucial for creating a positive momentum for the long list of other hopefuls in the pipeline.

"The initial response is fantastic, but everything is very valuation-driven at the moment and the final outcome will depend a lot on what will happen to the comps between now and pricing," says one source.

This will also be only the second company to conduct almost simultaneous offerings in Shanghai and Hong Kong after fellow construction company China Railway Group in December. While that deal went exceptionally well, the model does present a pricing challenge, given that the two markets trade at completely different valuations.

Like last time, the A-share price range was set first, allowing the bookrunners of the H-share offering to base their range on that, and CRCC will also fix the price on the A-share offering while the bookbuilding for the H-share portion is still ongoing. The H-share price will then be determined before the company starts trading in Shanghai to avoid any interference from a potential surge in the share price on day one. The company will list in Shanghai on March 10 and in Hong Kong on March 13.

The H-shares are offered at a price of HK$9.93 to HK$10.70 apiece, which according to sources translates into a pre-shoe 2008 price-to-earnings ratio of 26.6 to 28.7 times. This is slightly below the 28 to 33 times that a syndicate research analyst estimated to be fair value and also pitches the company at a discount of at least 10% to its peers even at the top end of the range.

According to Bloomberg data, CCCC currently trades at 32 times this year's earnings, while China Railway Group trades at 40 times. The latter is up 62% since its trading debut in early December, even though it has lost 19% since hitting a high of HK$11.60 on January 7.

CCCC, which specialises in the design and construction of ports, has gained 335% since it went public in December 2006. It currently trades 19% below its record close of HK$24.60 from November 2, but this still makes it an outperformer versus the Hang Seng Index which has shed 24% in the same period.

The bottom of the H-share range is at a modest 0.2% premium to the top of the A-share range, which translated into Hong Kong dollars is roughly equal to HK$9.91. The A-share range was set over the weekend at Rmb8 to Rmb9.08 per share. Chinese regulators have stipulated that the H-shares cannot be priced below the A-shares.

To help build momentum in the order book, Citi, Citic Securities and Macquarie Capital, which are the joint bookrunners for the H-share offering, have signed up nine cornerstone investors who will each buy $50 million worth of shares. Their combined investment of $450 million, which is subject to a 12-month lock-up, will account for about 20% of the H-share offering pre-shoe. The investors consist for the most part of usual suspects like Temasek, the Government of Singapore Investment Corporation, Lee Shau Kee, Citic Pacific, China Life Insurance, Chow Tai Fook, Bank of China and Cheung Kong (Holdings). They are accompanied by Yale University, which is a relative newcomer as a cornerstone on Hong Kong IPOs.

CRCC is offering 1.706 billion H-shares, of which 10% has been earmarked for Hong Kong retail investors. Clawback triggers apply, but because of the large deal size, the retail tranche cannot go beyond 25% of the total offering. The H-share offering will account for 14% of the company, or 15.8% if the 15% greenshoe is exercised in full.

The A-share portion, which was reduced to 2.45 billion shares from 2.8 billion at the last minute, will account for 20% initially but because it has no greenshoe, this will fall to 19.7% if the greenshoe on the H-share offering it put to use. According to announcements published in several state-owned newspapers yesterday, the reason for trimming the size was a reduced need for funds. Prior to the dual offering, the company was 100% owned by state-owned entity China Railway Construction Corporation (referred to as CRCCG). All the shares on offer are new.

According to the preliminary listing document, CRCC will use 80% of the H-share proceeds to buy equipment, in particular for its railway and light rail infrastructure construction projects in Nigeria, Saudi Arabia and Israel and for some of its ongoing highway projects. About 10% will go towards the construction of a cement plant in Nigeria that will help ensure a "smooth project execution" in this country and also hopefully improve the company's chances of winning new contracts there.

The company generated only 3.4% of its total revenues from overseas operations in the 11 months to November last year, but expects this to increase substantially in coming years given that about 40% both of the new contract value and of the backlog for the same 11-month period were made up of overseas contracts.

The H-share offering will remain open until March 5 and the final price will be determined on the following day. The two-day bookbuilding for the A-share portion, which is arranged by Citic Securities, will finish today and the price is expected to be fixed later this week.