The Hong Kong equity new issue market is driven by Chinese deals. After a spectacular year in 2004, this year has got off to a slower start, but the imminent $2bn IPO of Bank of Communications will show whether the Chinese government is likely to succeed in its even bigger sale of China Construction Bank. Mark B Johnson reports.
Hong Kong's role as a conduit for capital to mainland China is at its most visible in the equity capital market. Every year billions of dollars of Chinese stock is sold on the Hong Kong stock exchange.
The bulk of these issues come from state companies, and this year the highlight IPOs will come from state owned banks.
The first of these will be Bank of Communications, China's fifth largest bank, which is shortly to become the first pure mainland Chinese bank to sell stock overseas. BoComm set out in late May to premarket its roughly $2bn Hong Kong flotation, in which lead managers Goldman Sachs and HSBC will aim to sell up to 15% of its stock.
Hong Kong's importance for the Chinese equity capital market was underlined when BoComm shelved its plans to list simultaneously in Shanghai.
The Shanghai stock index has continued its slide this year, slumping by 15% to a six year low.
Fortunately for the Chinese government — and for the coterie of investment banks in Hong Kong waiting to float other Chinese banks and companies this year — the Hong Kong market has been more buoyant, declining by only 2.33% this year.
The offer will be a critical test of investors' confidence in the Chinese banking industry, and BoComm is clearly a good place to start this year's batch of big privatisations.
The government has put it at the head of the queue of flotations, believing that it is the strongest example of its efforts to restructure and recapitalise the banks. The bank also has a blue chip stamp of approval — HSBC Holdings bought a 20% stake for $1.75bn in July last year.
Waiting to see how BoComm's flotation goes are China Construction Bank, the nation's third biggest bank, which plans a $5bn IPO, likely to be led by China International Capital Corp and Morgan Stanley in the second half of this year, and the privately owned China Minsheng Banking Corp.
China Minsheng is already listed on the mainland, but hopes to float $800m of stock in Hong Kong before the summer and has applied for a secondary listing hearing. It would become the first privately owned Chinese bank to list overseas.
"There is keen anticipation surrounding the bank issues, as they will set important valuation benchmarks for what will be many years of issuance by the banks into the global markets," says Matthew Koder, head of Asian equity capital markets at UBS in Hong Kong. "China's growth will be dependent on global capital inflows and it is essential to achieve a fair balance of primary market pricing for the vendors and positive secondary market performance."
How clean is clean?
The big question for investors is whether the Chinese authorities and BoComm's management have done enough to clean up the bank before listing.
If they decide that is not the case — for a bank 20% owned by HSBC — then investors are likely to be put off bank stocks, regarding them as a risky way to participate in China's remarkable growth.
If investors judge that the authorities have made the right moves to slow but not stall the economy and, at the same time, restructure and recapitalise the banks, then they are likely to participate in force.
The challenge of the BoComm deal for Goldman Sachs and HSBC is to set a valuation benchmark for Chinese banks in the global equity capital market.
Making that challenge tougher is the fact that investors increasingly hold the pricing power, since many hedge funds and less committed investors have retreated from Asia in the past six months.
|2005 to build on 2004's sturdy platform|
2004 was an exceptional year for the Hong Kong stock market, which absorbed more than $15bn of new issuance from mainland China.
The themes that emerged so clearly — big privatisation IPOs, follow-on issues by partly state owned companies, disposals by strategic foreign investors and listings of private Chinese firms — will be played out repeatedly in the years ahead.
Newer trends include the flotation of banks, beginning this year; and the recycling of private equity investments into the public market, as with the highly successful $227m Mengniu Dairy IPO last year. Investors are particularly interested in companies that have been subject to the disciplines imposed by venture capital funds.
The IPO highlights of 2004 were the strong debut of Air China after its $1.07bn Hong Kong and London listing; the $1.8bn Ping An Insurance flotation; the $1.1bn China Netcom sale and the smaller $380m China Power listing.
As well as winners, there are usually some losers. Disappointing deals included the large IPOs of Semiconductor Manufacturing International Corp and China Shipping Container Lines.
The year also included follow-on offers for fresh cash, starting with the $400m Aluminium Corp of China deal in January, followed by the jumbo $1.73bn China Telecom sale in mid-May and later by the $1bn China National Offshore Oil Corp convertible bond issue.
There were also high profile divestments, including the $1.66bn disposal by global oil major BP of a 2% stake in China's biggest oil firm, PetroChina.
A host of small and mid-sized private Chinese companies listed in Hong Kong, such as Mengniu Dairy, or on Nasdaq, like online travel agent Ctrip.com.
So far in 2005, Shanghai Electric (Group) Co, which makes equipment for power stations, has completed its Hong Kong listing.
Other names queuing up to list include car makers Shanghai Auto and Dongfeng Auto, power producers Shenzhen Energy Group and China Guodian, as well as chip-makers Huahong NEC Electronics and Advanced Semiconductor Manufacturing Corp.
Despite fluctuations from time to time, there is essentially strong demand for Chinese issues. Equity issuance has been disappointingly slight in Asia so far this year, and long-only equity funds are keen to snap up high quality issues from China.
The vast pool of retail savings in Hong Kong might also emerge more strongly if market conditions improve.
And the Japanese retail market appears ever eager for Chinese issues. The Japanese public offer without listing (Powl) has become a standard feature of Chinese privatisations, being allocated 5% of a deal in bullish markets and up to 15% when institutional demand is quieter.
"The positive early response from international accounts to the spate of large Chinese privatisation issues is encouraging for sales that in total should be worth up to roughly $8bn pre-summer," says Koder. "Although the market has been patchy the anecdotal evidence is that the long funds are keen buyers of the big issues and are looking for sizeable blocks as entry points into the market."
Four large share sales from China are set to arrive together in June and July — BoComm, Minsheng, coal mining firm China Shenhua Energy, which has just priced its $2.95bn flotation, and shipping group China Cosco Holdings. But Koder does not believe they will create a problem of oversupply, as they are from three very different business sectors.
"The vendors will be able to achieve some or all of their pricing objectives," Koder believes, "given the broad spread of demand from international funds, domestic buyers and Japanese retail, which continues to have strong appetite for the larger Chinese issues."
One down, three to go
The first of the deals, for China's biggest coal producer China Shenhua Energy, was priced on June 8 at HK$7.50 per share, nearly at the bottom end of the range, to raise the equivalent of $2.95bn before greenshoe. Lead managers China International Capital Corp, Deutsche Bank and Merrill Lynch pulled in institutional orders worth nearly five times the stock on offer to them.
"The mood in the primary equity capital markets in Asia has been more muted than last year," says Jonathan Back, co-head of equity and derivatives capital markets for Asia at JP Morgan in Hong Kong. "Nevertheless, while some of the more speculative funds have withdrawn, this leaves the long-only buyers as again the most significant factor."
A senior ECM banker in Hong Kong warns that vendors will need to recognise that these are different conditions from late 2003 or most of 2004. "But the Chinese government has plenty of experience in the global capital markets and their privatisation programme has continued apace throughout many market ups and downs," he says. "In this instance, we are not facing difficult conditions, but simply less bullish times than in recent memory."
Premarketing began on May 30 for China Cosco Holdings, the world's seventh largest container shipping company and fifth largest port operator. The firm aims to raise up to $2bn in a Hong Kong IPO scheduled to price over the weekend of June 25.
The three joint arrangers, HSBC, JP Morgan and UBS, were set to launch formal roadshows on June 13 with a view to listing on July 4.
The newly created listing entity houses two businesses — ports, which produce about 30% of its operating profits, and container shipping, which makes the other 70%.
Narrowing the discount
The Minsheng Bank secondary listing is tantamount to an IPO, although the company already trades in 'A' share format on the mainland.
While not wanting to comment on that potential transaction, Willy Liu, managing director at Citigroup in Hong Kong, notes that the premium valuation of the 'A' share market over the Hong Kong bourse is diminishing, making it easier for companies to follow the lead set by ZTE Corp.
In December this Chinese telecoms equipment manufacturer became the first 'A' share company to complete a secondary listing on the Hong Kong Stock Exchange, raising nearly $400m.
The sale was priced at a 13% discount to the 'A' share price, well within the discount of up to 30% that many had been expecting. At that time the 29 companies with listings in both China and Hong Kong were trading at an average discount of about 45%.
"The mainland markets were fuelled by massive inflows of domestic money," explains Liu. "Those flows far outstripped supply but for the past six years the volume and size of domestic IPOs and follow-on offers has risen steadily to the point where there is an improved demand-supply situation."
Moreover, there is talk that qualified domestic Chinese buyers may be permitted to buy shares in Hong Kong, something that many believe would help pare the premium back. "In theory," says Liu, "the premium should eventually reduce to zero, making Hong Kong issues for mainland companies with existing 'A' share listings less challenging in the future than they are today."
The Chinese regulators control which companies can and cannot sell shares offshore. "The government is experienced in the capital markets and would not promote a mainland listed company for secondary listing in Hong Kong unless the valuation gap was bridgeable," says Liu. "There is no point in having the local shareholders diluted by issuance at a large discount in another market."
Local magnates sell out
Among Hong Kong's homegrown companies, none is making waves in the equity capital market to compare with the big Chinese IPOs.
A flurry of property companies launched convertible bonds in Hong Kong dollars in 2004 and early this year but that rush has petered out. The main straight equity deals have arisen from company owners selling blocks of shares to monetise their holdings or raise fresh capital.
Salient deals include Michael Ying's $554m sale of a 6.7% stake in Esprit Holdings in March. The transaction, led by Citigroup, was Ying's fifth disposal since 2003, as he reduced his shareholding from 42% to 23%.
Gateway status assured
The story of 2005 is China. After Hong Kong's return to China and the Asian crisis, the territory seemed destined to be swept away by the massive tide of business flowing to the mainland.
But the opposite has happened. Hong Kong has rediscovered its roots as an entrepot for capital and expertise into China — business is flowing from China to Hong Kong, and from the world to China through Hong Kong. Little wonder that the highest quality homes in Hong Kong are selling at record high prices. A succinct illustration of this is the fact that none of the three big Chinese IPOs on the way to market will involve a dual listing in New York.