Beijing Enterprises: Initial Public offering

Introduction

On May 20, 1997, the Board of Directors of Beijing Enterprises Holdings Limited, a Chinese Mainland company incorporated in Hong Kong, announced an initial public offering (IPO) of 150 million shares to raise funds for the expansion of several of its subsidiaries. It would list on the Hong Kong Stock Exchange on 29 May, 1997, and thereby join the select band of Red Chip Stocks. Two of the most established underwriters in Hong Kong, Peregrine Capital and Morgan Stanley, had agreed to be the lead managers of the issue. The underwriters had originally proposed an offering price of between HK$8.00 and HK$9.30. However, looking at the favorable market reactions to the announcement, the Board and the lead underwriters were considering whether to revise the price range upwards to between HK$11.50 and HK$12.50. They would have to make sure that the increase in price was justified by the Company's fundamentals.

In Hong Kong, a large number of Red Chip companies, which were extensions of Chinese governmental organizations incorporated and listed in Hong Kong, had experienced phenomenal success in raising capital through IPOs. Shanghai Industrial Holdings Limited, a Red Chip company, had a subscription rate for its IPO that was 158 times the number of public shares offered. Its shares, issued at HK$7.28 in May 1996, leapt more than five times in a period of 12 months. More recently, in January 1997, GZI Transport, a Guangzhou-based Red Chip company, had its shares oversubscribed 528.48 times, a record in the history of investor participation in an IPO.

Against this backdrop, the Board and the underwriters faced the task of pricing the IPO of Beijing Enterprises so as to raise the maximum possible capital through the offer.

Economic Reforms in China

The People's Republic of China (PRC) came into being in 1949. With the formation of the PRC the National People's Congress (NPC), comprising representatives of the provinces, autonomous regions and the municipalities, became the highest policy and rule-making body. For several decades the PRC followed a policy of complete isolation from the rest of the world. The economy was state-run and centrally planned. Around the late 1970s, however, there was a shift. China started experimenting with economic reforms under the stewardship of the father figure of China, Deng Xiaoping. The NPC had endorsed the policy of a "Socialist Market Economy" and the government relaxed the state's control over many industries in an effort to move slowly towards a market-oriented economy.

The first experiments in market-oriented reforms started with the agricultural sector in 1978. In the following year there were experiments with the Special Economic Zones to attract foreign capital and technology. The start was hesitant and there were setbacks. As a consequence of the market reforms, consumer demand went up, causing upward pressure on prices. This, combined with the government's decision to move away from planned prices, caused high inflation. The government implemented tight controls on capital, which moderated the GNP and also brought down inflation to historical lows in 1990. However, the pace of economic activity picked up again, pushing inflation up with it, and around 1994, it was dangerously high at 24.1 percent. The GNP growth was 12 percent. However, inflation fell in 1995 to 17.1% percent, followed by a further drop in 1996 to around 8.3 percent. The average inflation over the period from 1985-1996 was around 11.4 percent.

Macro-environment Analysis

After the significant economic reform was launched in 1978, a dramatically rising demand of capital was emerging in the businesses sector. Apart from the Shenzhen and Shanghai Stock Exchanges which had brought huge amounts of capital to Chinese enterprises, Hong Kong had become a crucial gateway for mainland companies to tap foreign capital. Therefore, some mainland corporations chose to list on the Hong Kong Stock Exchange to expand their businesses.

The macroeconomic situation will be discussed at first. From Exhibit 2, it can been seen that China had experienced a stable and fast economic growth in the previous years, so had some key international economic variables including the import and export volume and foreign exchange reserve. Moreover, the inflation rate had been put under control since 1995 and the RMB exchange rate was also steady during that period. All this information shows a booming economic performance of China and the situation was fairly favorable to launch a successful IPO.

Besides, the political movement also gave tremendous support for Beijing Enterprises' financing. Hong Kong would soon be reversed to the Chinese administration and thus mainland would have a closer tie with Hong Kong, which would cause higher expectations for Red Chip companies' share prices. And to avoid a sagging stock market before Hong Kong's return, the Chinese government would make every effort to maintain a strong performance of Red Chips share prices.

To speak of Red Chips themselves, they had been always backed by the Chinese government, no matter financially or politically. Their average performances are higher than the average of all HK stocks. And some Red Chip IPOs had got surprising oversubscriptions from investors. Under the whole favorable situation, it could be optimistically anticipated that investors would continuously give high expectations for Red Chips.

Therefore, it was sensible for the Board of Beijing Enterprises and the underwriters to revise the offering price upward. To realize an appropriate valuation of the share price and to help the company gain the biggest amount of capital, we will further have some discussion about the fundamentals of the company.

Beijing Enterprises Analysis

Beijing Enterprises Holdings Limited, here called "Beijing Enterprises" for short, was a subsidiary of the Beijing Municipal Government and acted as its primary overseas-listed vehicle.

Business Structure

Beijing Enterprises was a conglomerate with a business focus on Beijing. Beijing Enterprises had businesses interests in consumer products, infrastructure, services and high-technology industries were four promising industries. As the only overseas-listed conglomerate of the Beijing Municipal Government which, it was believed, would place the company in a better position to identify lucrative investment opportunities. All of the assets are of high quality and profitability