Initial Public Offerings

Initial Public Offerings: The next Chinese IPO "backdoor" candidate
A Taipan Financial News Research Report
by J. Christoph Amberger, Editor, Taipan
February 25, 2007

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If you follow the financial news, you know that Initial Public Offerings (IPOs) have a proven history of making people rich, practically overnight. In fact, in the last 18 months alone, American IPOs have delivered tremendous first-day gains, including Under Armour (UARM:NASDAQ), up 95%... American Commercial Lines (ACLI:NASDAQ), up 35%... Chipotle Mexican Grill (CMG:NYSE), up 100%... Intercontinental Exchange (ICE:NYSE), up 51%... and Brookdale Senior Living (BKD:NYSE), up 34% in a single day. That's not bad by any standard. Of course, it's nothing compared to what's happening on the other side of the globe. A new sector of the IPO market -- Asian IPOs -- has become a breeding ground for stock market millionaires. Now, I'm not talking about Asian companies going public in the United States... thanks in part to the tighter accounting standards introduced by the Sarbanes-Oxley Act, the US stock markets have lost a large number of potential IPO clients to London, and especially Shenzen and Shanghai in China.Now, there is a crucial difference between most of the Chinese IPOs that are going public in Shenzen and Shanghai and those IPOs you may remember from the IPO mania of the 1990s.

Initial Public Offerings: Not your 1990s IPO any more!

Whereas back in the 1990s, companies pushing into the market were start-ups with no revenues and wafer-thin business plans, many of the Chinese companies that are issuing shares today are large, solid businesses that have been trading in Hong Kong (as "H shares") and even on American markets (as ADRs) for years if not decades. Issuing new "A-shares" on the Shanghai stock exchange to them is less about raising capital -- but more like a trip to the ATM. Two factors have been working in their favor: The newly minted Chinese Middle Class (or "Money Class" as my colleague Todd Schoenberger used to call them) is flush with cash and as eager to gamble with it as their cousins in Hong Kong are at playing the ponies. The other reason is that the Chinese government created an artificially high demand for IPOs by not permitting new new equity offerings until May 2006. Now the floodgates are open: In the last three weeks of 2006, investment banks and companies whipped more than a dozen companies through initial public offerings on the Shanghai Stock Exchange alone.

Initial Public Offerings: The Taipan IPO Backdoor Strategy

As you will recall, one of them was our top recommendation from the September issue of Taipan. Less than two weeks after receiving approval from the Chinese Regulatory Securities Commission, Guangshen Railways (GSH: NYSE) made nearly $1.3 billion in its initial public offering on the Shanghai Stock Exchange. Guangshen sold 2.75 billion shares on the Shanghai exchange, receiving 3.76 yuan per share. Investors ordered 119.9 billion shares, nearly 44 times the number on offer, after Guangshen announced a range of 3.3 yuan to 3.79 yuan per share. (We're currently up 56% on our position and are holding on for more and more organic gains than those generated by short-time, IPO mania-driven volume spikes!)

Now, Guangshen attracted about 460 billion yuan worth of bids, making it China's fourth-biggest IPO in 2006, right after Industrial & Commercial Bank of China Ltd., Bank of China Ltd. and Daqin Railway Co. But even before the Guangshen offering, Chinese IPOs had raised a record $18.2 billion selling shares on Chinese exchanges, more than eight times the 2005 tally.

Our January pick, China Life Insurance Co. (LFC:NYSE), also rose considerably in the immediate aftermath of its rapid IPO... before fears of a bubble in Chinese stocks pushed the ADR back down over the short-term. (After a cyclical correction, LFC is gaining support again at a split-adjusted $45 per share, with rising Money Flow investment. Watch this level closely... it offers a good buying opportunity. I still consider LFC a great investment in the future population growth of China.)

But that's yesterday's news. The next big IPO is just around the corner. And again, we will be profiting from it through our IPO backdoor.

Initial Public Offerings: The next big thing

In mid-January, two small Chinese aluminum companies approved a buyout by their parent company. This by itself is an unremarkable event. But the buyouts will bring one of the largest and most successful metal-production companies in the world onto the Shanghai Stock Exchange.

Aluminum Corporation of China, Chalco for short, is a Hong Kong-listed company, plans to absorb two of its subsidiaries, smelter Lanzhou Aluminum Corporation and producer Shandong Aluminum Industry Corporation.

Lanzhou and Shandong are listed on the Shanghai Stock Exchange (SSE), and to assimilate the two companies, Chalco plans to replace their shares on the SSE with its own at the rate of 1.8:1 for Lanzhou and 3.15:1 for Shandong.

To give you an inkling of the magnitude of this event, Chalco is the second largest aluminum producer in the world. It provides an important resource for a growing industry, aluminum and alumina to China’s factories. The company registered 105.5 billion yuan ($13.2 billion) in sales last year -- 22.5 billion yuan ($2.8 billion) of that was pure profit.

Chalco plans to place 1.24 billion A-shares at 6.6 yuan each (approximately 85 cents) on the Shanghai Stock Exchange as soon as the Chinese Securities Regulatory Commission approves the buyouts. Chalco will then delist Lanzhou and Shandong and officially enter the exchange as the latest heavy hitter on the SSE block.

Chalco plans its Shanghai stock debut for March or April, according to reports.

Initial Public Offerings: An elegant solution to oversubscribed IPOs

Just like many hot Asian IPOs, this new offering will likely be heavily oversubscribed. People are going to stand in line to get shares — and most will be turned away disappointed.

Taipan's “secret backdoor,” however, once again will allow you to get shares of this Chinese IPO sensation... before the new shares public on the Shanghai Stock Exchange. Because Aluminum Corporation of China has been trading on the New York Stock Exchange as an American Depositary Receipt (ADR) under the symbol ACH: NYSE.

The stock has been trading at a 52-week range of $15.53-$27.90 and currently will set you back around $25 a share.

The trading volume for ACH already spiked quite nicely when the company announced its plans. Another spike, and a nice ride up in price, should occur as soon as news hits Western shores that the transaction has taken place in China. 

Initial Public Offerings: Executive Brief: ACH:NYSE

Buy Aluminum Corporation of China (ACH:NYSE) up to $27 with a short-term target of US$30 on the impending Shanghai IPO -- and a strategic long-term holding in one of China's key growth industries, with a holding horizon of 2-3 years. While we consider it preferable to buy foreign shares directly on the markets and in the currencies they're trading in, ADRs present the easiest option for American investors to easily take advantage of foreign opportunities.

We will be following and updating this recommendation in our monthly issues of Taipan.

Related Articles:
 
Video: “How to play the next Chinese Mega-IPO”: http://www.taipanfinancialnews.com/video.php?channelID=9&showID=84

“Chinese IPOs hit Wall Street”:
http://today.reuters.com/news/articleinvesting.aspx?view=CN&storyID=2007-02-03T012028Z_01_N02314674_RTRIDST_0_STOCKS-IPO-COLUMN.XML&rpc=66&type=qcna

“Bank of China I.P.O. Raises $9.7 Billion”:
http://www.nytimes.com/2006/05/24/business/worldbusiness/24cnd-ipo.html?ex=1306123200&en=5a27478f8c95fc60&ei=5088&partner=rssnyt&emc=rss

Read more about Chinese IPOs.

Copyright 2007, The Taipan Group, LLC and Dynamic Market Alert, 808 St. Paul St., Baltimore, MD 21201
All rights reserved. No part of this report may be reproduced or placed on any electronic medium without written permission from the publisher.
Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed.