UNTIL A FEW weeks ago Asia offered a glimmer of hope in a gloomy global economy. The region seemed to offer a prospect of growth – especially in China – in welcome contrast to stagnation in Europe and the US. Asian companies and their bankers had looked forward to capital raising and making new investments. Then the first reports emerged of a virulent life-threatening illness spreading out from a focus in southern China.
In the wake of growing panic, Euromoney asks a banker what is ostensibly a simple question: what will investors be seeing from Asian corporates in the American depositary receipts market over the rest of the year? But it plainly poses him problems. There is an uncomfortably long pause as he attempts to organize his thoughts into a positive and upbeat answer. After a few more seconds, a wry smile appears on his face. He gives up. “It’s not going to be very good is it?” he says. “We are not going to see many new ADRs coming out of Asia for a while.”
The banker has just returned from New York and looks thoroughly depressed. He continues: “The Iraq war is over and now investors are focusing on the trouble in Asia – In particular China and Hong Kong.” It’s a clear reference to the struggle being fought in the region’s hospitals to control the spread of severe acute respiratory syndrome (Sars). The banker continues: “China could be a problem for the entire region. People in the US are starting to realize that the data about the number of victims coming out could be just the tip of the iceberg. And when they start reading numbers in the thousands then the psychological impact on the region’s markets and local companies will be dreadful.”
Asian corporates with ADRs in the pipeline – even those already selling ADRs – could find themselves quickly out of favour if US retail and institutional investors are spooked further.
It might just be a case of investors being oversensitive. But as the Chinese authorities become more open about the spread of the disease, fund managers too are reading that the number of Sars cases is growing and are struggling to assess the consequences for corporate profits. Just two months after most people became aware of the Sars threat, economists and analysts are already predicting that Asian corporates could be severely hit as consumers decide to quarantine themselves at home. Citigroup, for example, has already cut China’s GDP growth forecast of 8% to between 6% and 6.5%.
The new nervousness couldn’t have come at a worse time for the Asian ADR market, which had already been hit by falling global equity markets. Last year, the $6.9 billion raised in ADRs globally was the lowest for 10 years. The dizzy heights of 2000, when $30 billion was raised, now seems a distant memory.
However, despite last year’s dismal overall figures, the Asia-Pacific region seemingly offered relatively good news for the primary side of the business. Of the $6.9 billion raised, some 65% ($4.5 billion) was for Asia-Pacific companies. And of the top five ADR transactions globally last year, four were completed by Asian corporates. AU Optronics and China Telecom came to the market for the first time, raising $659.5 million and $490.8 million respectively.
Korea’s Kookmin Bank and SK Telecom successfully completed secondary tranches for their existing programmes. Kookmin Bank raised $694.9 million and SK Telecom pulled in $430.8 million.
A bouyant secondary market
In the secondary market, Asia also showed promise. It was the only region to enjoy an increase in the number of ADRs traded, up from four billion to five billion, and also an increase in the value of ADRs traded, which jumped from $73.5 billion to $76.5 billion.
Even now, Gary Peek, regional director of Bank of New York’s depositary receipts division in Hong Kong, believes that Asia will continue to be a driving force in the ADR market. “We envisage that the majority of ADRs will be out of Asia,” he says. He admits, though, that volumes will be low in the short term. “On the negative side we have seen very little issuance because of geopolitical uncertainties and macro-investor confidence,” he says. “But this applies to all regions. On the positive side companies are still looking to do equity raisings and there has been an increase in activity as companies in the region appoint investment banks.”
Certainly there is a pipeline of equity offerings with possible ADR tranches attached. In Korea, computer display products company LG Phillips is planning to make a $1 billion offering. From China, Bao Steel, China Netcom and PTIC Information are about ready to venture into international equity capital markets. A little farther down the road, Chinese insurance companies such as China Life and Ping-An are expected to announce plans for dual listings.
Taiwan’s and Korea’s financial sectors are looking for ways to recapitalize. Korea’s Woorie Bank and Shinhan Bank have been touted as likely to approach the ADR market this year. And Chung Hwa Telecom of Taiwan has been making the right noises. In India, Nalco, Infosys and BPL Cellular are all waiting in the wings with transactions worth between $200 million and $300 million. Even banks in Thailand and the Philippines are rumoured to be showing an interest in establishing ADR programmes. In doing so they would be joining Kookmin Bank and India’s HDFC and ICICI banks, the only banks in Asia issuing ADRs.
But with so much uncertainty about, no-one can be too sure when these deals will emerge from the pipeline.
It’s not just the generally weak equity markets and uncertainty about Sars that could stymie Asian companies thinking of selling themselves to US investors. Regulatory issues have also taken on a new prominence in the wake of US corporate scandals.
Corporate governance and transparency have become the new obsession. This culminated in the New York Stock Exchange publishing new-issue guidelines and the passage of the high-profile Sarbanes-Oxley Act. Asian corporates and bankers alike are unsure of the impact on the Asian ADR market. “It’s the main question in everyone’s mind,” says Sebastian Sperber, a partner at law firm Cleary, Gottlieb, Steen&Hamilton. “Will the Sarbanes-Oxley Act discourage Asian companies from issuing in the States?” he wonders. “And will they recede from the ADR market with concerns about the heightened level of regulation?”
Some Asian corporates are plainly uneasy about the new legislation. Under Sarbanes-Oxley, CEOs have to certify the accuracy of their company’s filings and risk imprisonment if the figures published turn out to be false. Given the antics of certain Asian CEOs in the past, it’s not surprising that some are slightly apprehensive. Corporate misdeeds are not solely a US phenomenon. Korea’s SK Global is a recent example of senior management playing with numbers. And Posco’s chairman was recently ousted. Last month Yoo Sang-Boo was removed from his position for, among other things, deciding to allow the company’s shareholders to buy and furnish for him a large luxury apartment without actually telling them. As Tom Vita, a partner at law firm Norton Rose, puts it: “The statute definitely raises the stakes for CEOs.”
According to bankers, Sarbanes-Oxley is causing particular discontent among Chinese CEOs. Their government is pushing for the country’s larger companies to be listed in both Hong Kong and the US, much to the angst of those who will take charge. One source says that China Steel’s management is involved in behind-the-scenes arguments with China’s authorities about the idea of two listings and putting themselves under such intense regulatory scrutiny. “In essence all the Chinese government is doing is selling down its stakes in the company and wanting management to do a dual listing,” the source says. “The management, not the government, would then have to take on all the obligations of the act. And the management don’t want to.”
There is no suggestion that the company’s senior managers are suspect, it’s just that they may not want to lose too many nights’ sleep worrying about figures that have been provided them by others. This could be a worrying trend for ADR banks that see China as the promised land. The most recent deals – Sinotrans’ $420 billion IPO and Bank of China (HK)’s $2.67 billion flotation – had no ADRs attached.
The Price of prominence
The benefits and drawbacks of seeking a US listing are finely balanced at a time of heightened scrutiny among US regulators and reduced risk appetite among American investors. The CFO of a Hong Kong corporate who didn’t want to be named says: “We have seen companies hold back their listing process in the US because they don’t want to take this risk yet. However, our conclusion is that if we want to get an ADR done then we will live with the requirements because it will make us more world class. It’s the price of doing business in the US.”
The same line is taken by David Russell, Citigroup’s managing director for Asia Pacific ADRs and GDRs. “Sarbanes-Oxley has definitely raised the bar and it could be the reason why some Chinese corporates pull out. Companies can still get a new issue away without an ADR tranche but investors want top-tier corporate governance standards. And an ADR is the easiest way to prove they have them.” US investors are so wary about financial skeletons tumbling out of closets that companies meeting higher-level ADR disclosure requirements may at least provide reassurance that their stock constitutes a safe place to park their money.
This, though, raises the prospect that smaller Asian companies will be penalized by the new requirements. Sperber rebuts this argument. “I think that Sarbanes-Oxley will be happy to have companies of any size come to the US markets,” he says. “It doesn’t distinguish between big and small.” However he concedes that smaller Asian companies may have some reservations about the practicality of getting down to the nitty-gritty of going for the listing. “It has created the perception of a burden for the smaller companies but it really isn’t going to be so crushing,” he says.
Any Asian companies – big or small – that do decide to pursue an ADR programme might want to consider carefully what’s in it for them other than prestige. They should take note of what happens to shares after the initial euphoria of listing. Trends show that many of the 116 Asian ADR programmes will become extremely illiquid. In many cases share ownership and secondary trading will flow straight back to the local market. Marcus Brown, director for equity capital markets at UBS, says: “At the moment there are really only four Asian ADRs that are actively traded: Taiwan Semiconductor Manufacturer, United Microelectronics Corporation, KT Corporation and SK Telecom. Bar these four the market quietly tails off into insignificance. Every now and then you will get a new issue and it will be active but these tail off too.”
When AU Optronics first hit the US in May 2002 it was turning over on average $19 million a day. It’s now below $1 million. The same has happened with China Telecom. When it was priced in November it was trading $20 million-worth of shares a day; it has now slumped to around $1.5 million. Danny Palmer, a managing director in Morgan Stanley’s global capital markets, agrees with Brown. “Investors vote with their feet,” he says. “There are a core number of companies with ADR programmes that have a critical mass. The remainder just wither on the vine.”
Kenneth Tse, AsiaPacific regional head for JP Morgan’s ADR group, is uncomfortable with such negative assertions: “The ADR market is very concentrated,” he says. “Of the 2,000 programmes worldwide the top 100 account for 91% of the trading volume. Yes, ADR programmes have a reputation for being illiquid but it’s unjustified and unfair because they are no different from any other stock market. Just look at Hong Kong’s Hang Seng.” In the Hong Kong index, for example, only a few stocks, such as HSBC, are that liquid.
Kenneth Poon, managing director at Merrill Lynch, takes umbrage at the suggestion that ADRs have a tendency to migrate back to their local markets. “Take TSMC and UMC for example,” he says. “Why would they migrate back when there is a premium? Korea also has some vibrant ADRs that have not traded back. If there is migration then that generally means that the company is not good enough.”
Figures show that TSMC, UMC, Korea Telecom, and several Indian ADRs have had none of their programmes in the US slip back to their local market. However, these do seem to be the exception. Other high profile-names such as Kookmin Bank have, according to figures supplied by Morgan Stanley, seen 70% of their initial ADR return home.
Poon believes that it’s all a result of the failure of Asian companies to get their message across and build up proper investor relations. “Bigger companies tend to do a lot of conferences, non-deal roadshows and result updates,” he says. “They are constantly on the road. The smaller companies may do deals that become orphaned.”
Some leading ADR banks undertake some of this investor relations work themselves on companies’ behalf. Bank of New York’s Peek says: “We help in many IR activities. It’s in our interest to get the name of the company in the market for investors. Bank of New York is not an investment bank so we do not have those perceived conflicts of interest. We don’t write research on them.”
But strong investor relations are, for some companies, far from enough. Smaller-cap Asian companies will have to come to terms with the fact that they will never trade like TSMC and UMC, which have built up quite a following in the US. US investors are now so risk averse that they will only look at Asia’s top-tier companies. However, unless these corporates get to grips with the theories and practices of transparency and corporate governance, it doesn’t matter how blue chip they are in the Asian context – they will still be avoided by cautious money in the US.
