Spilling the tea on Hong Kong IPOs

On April 23, Hong Kong welcomed its largest initial public offering of 2024 so far, as bubble-tea maker ChaPanda debuted, raising HK$2.6 billion ($332 million). The deal size pales in comparison with previous largest offerings, being half the size of liquor company ZJLD Group’s 2023 IPO, a quarter of battery maker CALB’s 2022 listing, and a mere 20th of short-video platform Kuaishou’s 2021 debut.

Nevertheless, the market struggled to digest the offering, with ChaPanda’s stock price plummeting 27% on the first trading day.

“There is still a huge mismatch in pricing expectations between issuers and investors,” a banker involved in the deal tells Euromoney. “ChaPanda sought a price-to-earnings ratio of 15 times, but the market was only willing to pay 10 to 11 times.”

This dip wasn’t entirely unexpected given the lack of cornerstone investors, which typically stabilize new listings.

According to insiders, the IPO was another non-market-oriented transaction, akin to many Hong Kong listings in the last two years. The IPO’s investor pool primarily comprised local governments and players across the company’s supply chain, including both upstream and downstream business partners. It lacked global institutional investors.

The absence of those global institutional investors in such deals has eroded the importance of international investment banks, whose job it is to bring these investors to the table.

The ChaPanda deal was led by CICC and a group of Chinese investment banks and brokers, with Citi being the sole foreign bank involved. It took the role of joint global coordinator and joint bookrunner.

“In the past, companies seeking Hong Kong IPOs coveted the presence of big global investment banks to enhance their profile,” a Hong Kong-based lawyer at one leading US law firm notes. “However, this has changed drastically, with some companies deliberately avoiding foreign banks to minimize uncertainty. Last year, when foreign banks withdrew at the last minute, it put issuers in a very difficult position.”

In 2023, foreign investment banks withdrew from at least 10 IPOs. Goldman Sachs ceased coordinating roles in five successive IPOs, with Bank of America, JPMorgan and pre-UBS acquisition Credit Suisse all following suit.

This has changed the IPO process. Issuers are turning to their existing investor networks to fill the funding gap, while investment bankers have lost their pivotal role in deal making.

Lawyers and auditors are now often separately pitched and recruited by issuers based on recommendations from their social circles, rather than following suggestions from their investment bankers.

The sensitivity of the situation is such that everyone Euromoney spoke to for this article would only do so off the record.

Commitment gap

There are some signs of positive change amid the ongoing struggle for liquidity in Hong Kong,

A senior executive at a top Chinese investment bank confides to Euromoney that while US dollar institutional investors, or ‘long money,’ had completely stopped considering Hong Kong deals last year, they have recently begun to reevaluate these opportunities, although there is still a gap between interest and actual commitment.

Another lawyer at a prominent firm reveals to Euromoney that the number of IPO projects launched in the past month exceeds the total number of projects initiated in the previous six months combined.

With the prospects of listing on mainland exchanges now thoroughly diminished, these companies are decisively shifting their focus to Hong Kong IPOs

An IPO lawyer

The quasi-closure of the A-share IPO market for out-of-favour sectors such as consumer has driven high-quality mainland companies to explore alternative listing options.

The new chairman of the China Securities Regulatory Commission (CSRC), Qing Wu, has emphasized strict IPO entry control since assuming office in February, extinguishing the hopes of many founders and leading to an influx of good companies to Hong Kong.

“Last year, despite A-share IPO restrictions, some founders adopted a wait-and-see approach, hoping for a relaxation,” an IPO lawyer at a Hong Kong-based US law firm explains. “Some small companies even considered a Beijing Stock Exchange IPO [a bourse launched in 2021 currently focusing more on the debt market] as mainstream Shanghai and Shenzhen exchanges were not feasible options. However, even the Beijing Stock Exchange has proved unwelcoming. With the prospects of listing on mainland exchanges now thoroughly diminished, these companies are decisively shifting their focus to Hong Kong IPOs.”

Drink-fuelled

ChaPanda, also known as Chabaidao, is a good example of one of those solid businesses with strong financials pursuing a Hong Kong IPO. Launched in 2008 as a mom-and-pop shop in Chengdu in southwestern China, ChaPanda took a decade to reach 100 franchises.

In 2018, the introduction of two wildly popular drinks, a Hong Kong-style Mango Pomelo and a soy milk-based beverage fuelled rapid expansion to 500 franchises within a year.

Today, ChaPanda boasts over 8,000 franchises across 31 Chinese provinces and cities.

From 2021 to 2023, ChaPanda’s annual revenue grew from Rmb3.6 billion ($510 million) to Rmb5.7 billion, while profit grew from Rmb779 million to Rmb1.15 billion, maintaining gross profit margins of around 35%.

This robust performance contrasts starkly with Nayuki, the first Chinese bubble-tea company listed in Hong Kong in June 2021. Despite posting losses exceeding Rmb130 million in the three years prior to its IPO, Nayuki, listed at the peak of the Hong Kong market, and achieved a higher market capitalization upon IPO than ChaPanda. This proved unsustainable, as Nayuki’s losses widened to Rmb461 million in 2022, and it only managed a marginal Rmb20 million profit in 2023.

Nayuki now trades around HK$2.5, a staggering 90% drop from its IPO price.

“The Hong Kong market has traditionally prioritized profits over revenue,” points out the head of consumer lending at a Chinese bank in Hong Kong. “However, during market booms such as in 2021, we saw companies relying on internet traffic to achieve high growth, generating revenue but no profits.

“At the time, some investors used price-to-sales ratios for valuation rather than the typical price-to-earnings ratio,” he adds. “Today, the industry consensus has returned to business fundamentals; top-line growth without net profits is meaningless.”

A wave of Chinese bubble-tea companies is now following in ChaPanda’s footsteps to Hong Kong listings.

Market leader Mixue Ice Cream & Tea, boasting nearly 30,000 franchises, pivoted from an A-share IPO filed in September 2022 to a Hong Kong listing in January. At the same time, Zhejiang-based Guming filed for a Hong Kong IPO, with Shanghai-based Auntea Jenny following suit in February.

Reportedly, all well-known Chinese bubble-tea companies, including Sexy Tea and Chagee, are now preparing for Hong Kong IPOs.

These bubble-tea makers have taken care to distinguish themselves from Nayuki in terms of profitability. In the first nine months of 2023, Mixue, Guming and Auntea Jenny earned net profits of Rmb2.4 billion, Rmb990 million and Rmb320 million respectively, according to their prospectuses.

The key to their early profitability lies in their franchise-based business models, a more capital-light approach than Nayuki’s directly operated branches.

In fact, these companies have evolved beyond traditional retail, leveraging their supply-chain prowess. From 2021 to 2023, 95% of ChaPanda’s revenue stemmed from selling goods and equipment to franchisees.

Market leader Mixue takes this approach to the extreme, forming the core of its competitive advantage. Some 60% of the beverage ingredients provided to franchisees are produced in-house, with core ingredients being 100% self-produced. The company sources raw materials from six continents and 35 countries while establishing its own planting bases. In China, Mixue boasts a 1.43 million-ton annual production capacity across five factories.

The shift towards consumption downgrading in China since the pandemic has also played into the hands of players like Mixue, which can control costs tightly and offer drinks at around Rmb8, a third of the price of Nayuki’s Rmb24 offerings.

This focus on affordability has resonated with consumers in an environment of falling home prices and job insecurity.

Pressures

At the market peak, unprofitable companies could easily be listed in Hong Kong, luring investors with growth promises that failed to materialise.

Today’s market is very different, so why are profitable companies like ChaPanda still rushing to list there?

First, pressure from investors, often in the form of repurchase agreements, gives investors the right to resell their shares back to the company if milestones, like an IPO, are not met.

ChaPanda, for example, obtained its first round of funding of around Rmb1 billion in 2023 from private equity investors, including Orchid Asia and Loyal Valley. It was a pre-IPO round clearly pointing to an IPO exit.

While the IPO pricing puts the firm’s capitalization at Rmb25.8 billion, allowing some gain for its private equity backers, the company’s current valuation of just Rmb17 billion is already lower than the pre-IPO valuation of Rmb18 billion, raising questions about the pace of the IPO push.

Second, fierce competition. The franchise model offers profitability with minimal capital outlay but also attracts many competitors, as shown by the long list of bubble-tea makers seeking Hong Kong IPOs. This has created a franchisee’s market, forcing brands to aggressively vie for partnerships, often sacrificing margins for growth. Well-capitalized players can better seize territory and establish presence before market saturation.

Interestingly, these bubble-tea makers originate from different Chinese cities and are often backed by local governments, as seen in ChaPanda’s IPO, that play a role in pushing their industry leaders to become national champions. Could the rush to Hong Kong IPOs also be a competition between local governments?

Third, as the battle for market share intensifies, ambitious bubble-tea makers are looking beyond China, with Hong Kong serving as a launching pad for branding in other Asian markets. ChaPanda has opened its first overseas shop in Seoul, while Mixue boasts over 4,000 shops abroad, primarily in Southeast Asia.

Liquid challenge

Hong Kong’s deepest issue remains liquidity, with no clear resolution in sight.

J&T Express, which listed last year at a valuation of HK$105.7 billion, a steep 30% discount from its private market fundraising valuation, has seen its current market cap cut in half. It is now hovering around HK$56 billion.

Taking heed of this cautionary tale, Alibaba-backed express delivery firm Cainiao has put the brakes on its Hong Kong listing plans, with co-founder and chairman Joseph Tsai citing the liquidity crunch as the key deterrent.

Investment banks in Hong Kong continue to face layoffs due to the paucity of deal flow. All global investment banks are retrenching, with Morgan Stanley reportedly cutting 50 investment bankers, 80% of them in Hong Kong and the mainland. Chinese investment banks prioritize stability but still cut staff discreetly.

Global firms are certainly diverting their attention to other markets, such as India, but there are glimmers of hope.

UBS recently upgraded Hong Kong to overweight, citing its sharp year-to-date underperformance, rising dividend support for stocks, and the potential benefits from a tourism recovery.

ChaPanda was the first to list in the new wave of Chinese bubble-tea firms, and the market’s appetite for homogeneous bubble-tea shop businesses is not infinite.

All eyes are now on market leader Mixue, the most sought-after target in the sector due to its scale and supply-chain moat.

It has appointed Merrill Lynch, Goldman Sachs and UBS as IPO coordinators – telling in an environment where Chinese investment banks are gaining prominence.

The involvement of these firms begs the question: will even Mixue’s strong market position be enough to attract global investor interest? The outcome of the tea firm’s IPO journey could serve as a barometer for Hong Kong’s ability to retain its status as a prime destination for high-profile listings.