Bill Simpson wrote an analysis of China Hydroelectric (CHC) to TradingIPOs subscribers on January 13. In its debut Monday, January 25, the company priced its initial public offering of 6 million units at $16 per unit, within the expected range, raising $96 million.
The text of Mr. Simpson's original writeup follows:
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China Hydroelectric plans on offering 3.125 million units at a range of $15-$17. Each unit will consist of one ADS and one warrant.
The warrants will be exercisable upon ipo settlement at a price of $15. The ADS and warrants will trade separately post-ipo with the warrants under the ticker CHC and the warrants under the ticker CHCW. The warrants are exercisable for a period of up to four years post-ipo. They have value only if CHC is trading above $15 as that is the exercise price of all warrants.
Broadband Capital is leading the deal, i-Bankers, Morgan Joseph and Pail co-managing. Note that Broadband Capital also was the lead underwriter for the (thus far) very successful 2009 LIWA ipo.
Post-ipo, assuming all warrants will eventually be exercised, CHC will have 52.1 million ADS equivalent shares outstanding for a market cap of $834 million on a pricing of $16.
Ipo proceeds will be utilized for hydroelectric company acquisitions.
Vicis Capital Management will own 30% of CHC post-ipo, CPI Ballpark Investments 21%.
From the prospectus:
'We are a fast-growing consolidator, operator and developer of hydropower plants in China, led by an international management team. We were formed in July 2006 to acquire existing small hydroelectric assets in China and aim to become the PRC’s largest independent small hydroelectric power producer.'
CHC was formed in 2006 and since 2007 has purchased 11 small hydropower plants located in four Chinese provinces. Installed capacity currently is 376.6 MW. CHC generates revenues by selling electricity generated by hydropower capacity to local power grids.
Sector - Hydropower is the largest source or renewable energy in China. Electricity generated from hydropower in China has grown at an annual rate of 12% over the past decade.
Growth plan is to continue to acquire small hydropower plants. CHC has recently acquired two plants, one of which has yet to begin construction.
**With a roll-up growth strategy, ideally you want to see a clean balance sheet on ipo. Unfortunately that is not the case here. Post-ipo, CHC will have net debt of $194 million. Through the first nine months of 2009, debt servicing ate up 74% of operating profits. There is sort of a double whammy in effect here. CHC has done private stock placements to raise cash. They've also given equity considerations (in preferred shares) in a few of their acquisitions. This has led to a high share count on ipo leading to a sizable $800+ million market cap on a $16 pricing. However they've still run up sizable debt in their acquisitions. So sizable, that at least for the present, the debt load is eating into nearly all operating profits. This is not what you want to see in a roll-up strategy, not at all. Going forward CHC will continue acquiring and will need to do so by adding more debt to the bottom line as the cash flows are simply not there due to the current debt load. I do realize that revenues from recently acquired plants will grow year over year as CHC operates them for a full fiscal year. The point is not that CHC will not increase revenues or grow, it is that they are in a precarious balance sheet situation for a company implementing a roll-up acquisition strategy.
This is a very interesting niche with substantial potential. However this particular company is coming public with one hand already tied behind its back. I would expect substantial share dilution here going forward simply due to the fact CHC still needs to raise a lot of money post-ipo.
Accounts receivables - Nearly 50% of CHC's revenue growth the first nine months of 2009 is sitting in the 'accounts receivables' line. Put another way, 30% of 2009's revenues have yet to be actually collected. Some of this very well may be a timing issue, however it's something to keep in mind and follow over the next few quarters. Along these lines, CHC GAAP-wise shows a nice operating profit through the first nine months of 2009, but cash flows are actually negative.
**CHC's ipo looks to be the 'wrong' deal in the 'right' sector. Hydropower in China is a growth business as the PRC looks to expand clean/renewable energy projects. Unfortunately, CHC's balance sheet gives me pause here as I have reservations about their ability to execute their growth plans over the coming years. This is a high risk deal that has a better than average possibility of 'blowing up' sometime in the future. Best case scenario here is ipo investors get massively diluted over the coming years as CHC does multiple equity offerings to fulfill roll-up growth strategy and clean the balance sheet.
2009 - Through the first nine months, full year revenues appeared on track for $42 million. Gross margins should be 63%, operating margins 43%. Plugging in debt servicing and taxes, net margins should be 9%. Earnings per share of $0.07.
Conclusion - The low EPS here does not bother me, the growth plan coupled with the balance sheet and debt servicing costs do. I am interested in this sector, however with this particular deal I am not interested in range.
Author's disclosure: None.