Hot Response To ChinaHongxing's Share Placement

DMG Research - Hot response to Hongxing share placement

Despite volatile market conditions and the prospect of earnings dilution on a per share basis, listed China-based shoemaker China Hongxing Sports has received unexpectedly strong response to its $472 million share placement. All 400 million new Hongxing shares have been snapped up largely by institutional buyers. China Hongxing said last week that the placement at $1.18 a share was a 5.14 per cent discount to the weighted average price of $1.2439 on Nov 14.

The stock fell 25 cents yesterday to close at $1. Listed here in late 2005, the Fujian-based sports footwear and accessories specialist is one of the top three players in China, with over 3,000 stores across the country - just behind its Hong Kong-listed rival, Lining, which has 5,000 stores.

The placement was done primarily to fund its aggressive brand-building across China in the lead-up to the 2008 Summer Olympics in Beijing next year. Some $330 million of the estimated net proceeds of $458 million, will go towards the company's expansion of its sales & distribution network, advertisement & promotion, and renovation and upgrading of older stores. The balance will be used to set up four logistic centres, for production capacity expansion and for general working capital.

While noting that FY08/09 earnings per share will be diluted by about 15 per cent by the placement, analysts nevertheless note that this brand-building and profile-raising exercise is critical for long-term sustained growth in a highly competitive Chinese market, where over a dozen players compete tenaciously, often with their stores sitting next to each other on main streets of cities across the country. Although downgrading the price target to $1.32 (from $1.48), Kim Eng noted that China Hongxing's revenue would increase by one to 3 per cent. 'We have also increased gross margin assumptions to reflect lower outsourcing costs,' it said in a note yesterday. 'We continue to like Hongxing as a key beneficiary of the Olympics and China's rising consumption spending.'

About $195 million of the placement funds will be used to secure prime 100-200 sq m stores, which require 24 months of rent as deposit. Hongxing's strategy has been to offer financial assistance to its distributors to fund this rental advance, and collect the money back over the second and third year, to be re-deployed for opening newer tores. China Hongxing, which is fast expanding its sales and distribution network, is also upgrading its older stores to reflect a younger and more dynamic brand image. And with TV stations already demanding huge upfront payments for air-time in the lead up to the Olympics, a portion of the funds raised is also being set aside for a media blitz.

Recently, the group posted a more than doubling in third quarter net profit to 91 million yuan (S$17.8 million), thanks to stronger margins, higher sales and better product mix. Net earnings for the first nine months also more than doubled to 260 million yuan.