China: The curious case of Guotai Junan
The Chinese brokerage’s fixed-price IPO in Hong Kong is being hailed as a step forward for a mainland-distorted market. But is it?
Let’s be clear: Guotai Junan Securities Co’s fixed-price Hong Kong IPO, which begins trading Tuesday (April 11), is not a solution to the exchange’s price-discovery problems. It is a symptom of them. But it might, at least, be pointing us in a better direction.
The mainland brokerage’s HK$16.5 billion ($2.1 billion) float is unusual for having dispensed with the standard price range bookbuilding process and gone out with a single offer price.
To understand the reasoning for this, one has to look back over the past two years of Hong Kong IPOs, which have been characterized by high issuance volume and dreadful performance. Hong Kong had more listings than any other exchange last year – $24.5 billion. But, according to local online broker Boom.com, out of 110 listings since January 2016, 50 are still below their listing price as of April 6, despite the Hang Seng having risen 15% over that time and almost 25% since lows in February 2016.
Performance has been so bad because many deals – chiefly from mainland enterprises and particularly state-owned ones – have simply priced at the wrong level. This is due to the distortion effect of Chinese onshore money, which manifests itself in two ways.
One is the so-called friends-and-family effect, wherein a mainland issuers decides what price they want and enlists friendly and chiefly domestic enterprises to commit to that price, even though that’s not what the international institutional market would pay based on an analysis of the issuer’s merits.
To be honest, for the last few years, we could have had fixed-price offerings, and there wouldn’t have been much difference - Banker
The second, most acute in the last two years, has been the desire for holders of Chinese money to move it offshore, partly to diversify but increasingly because the renminbi is depreciating.
“People are saying: ‘I don’t mind taking a 20% or 30% haircut on my dollars if they are offshore,’” explains one banker. “If that’s the price I have to pay, it’s worth it to me.”
These two distortions have led to a Hong Kong market that, increasingly, has no traditional process of price discovery.
When Postal Savings Bank of China pre-sold 77% of its $7.6 billion IPO last year to cornerstones, it marked something of a nadir: the price was set not by a considered evaluation of risk and return by sophisticated international investors, but by a gang of unrelated mainlanders led by China Shipbuilding Industry Corporation – not an obvious ally for a postal savings bank, yet one which ended up with almost $2 billion of stock.
International institutions won’t go into deals like this because they don’t think the price is correct, and bookbuilding is not giving them the facility to bring that price to a more reasonable level because of the distorting effect of the cornerstones.
Retail investors in Hong Kong, meanwhile, are being sold badly priced deals, alongside the constant threat of an overhang from those cornerstones – whose exit from their positions, if it ever comes, may not be through a visible and transparent block trade but behind the scenes.
“We are in a position now,” says another banker, “where generally IPOs have close to zero institutional participation.
“It is not an institutional market. In fact, it’s not really a market at all. Issuers name their price, and they are able to cobble a deal together through various different sources without needing or seeking professional money.”
Safe brings a change
Suddenly, though, a change. In recent weeks, word has spread that the State Administration on Foreign Exchange (Safe) has started adding a caveat when it grants permission for money to go offshore to invest in IPOs.
Safe, apparently, has been saying: ‘Go ahead and invest, but that money needs to come back – all of it – over a certain period of time.’
This makes a considerable difference to people who have previously gone into deals expecting to make a loss, but being prepared to wear it in order to get the money offshore.
“It completely changes the equation for someone agreeing to be a friend-and-family buyer or a cornerstone,” says a banker. “And if it happens – which it won’t overnight – we will move to a more normalized market where it’s going to be difficult to price deals purely with onshore money. Value will finally have value.”
How does that get us to Guotai Junan’s fixed price deal?
The transaction still has cornerstones, but they look a little different to those we saw in, for example, Postal Savings Bank. The $598 million allocated to cornerstones made up about 30% of the deal, and the biggest of them was a $388 million commitment from the UK private equity firm Apax Partners.
Another international name, Tokai Tokyo Securities, is also committed. There were some very large orders in the book from institutions that one would ordinarily expect to see appear as a stated cornerstone in the prospectus, but this time they preferred to come in to the book through orders rather than a disclosed anchor commitment.
The fixed price bit was not, Euromoney understands, the idea of any of the 20 bookrunning banks (of which four, Bank of America Merrill Lynch, Goldman Sachs, Shanghai Pudong Development Bank and Guotai Junan International, were joint sponsors), but something the issuer came back with.
It is thought that these cornerstones investors, in light of Safe’s changing attitude to capital repatriation, said that they were not prepared to pay above a certain level; and that the issuer, frustrated at the tide having turned against it at an inopportune time, responded by saying it would take away the bottom of the range.
It would be wrong to think of this deal as a structure that has come about to right the wrongs perpetrated against Hong Kong investors. It is, instead, a haggling outcome that reflects modern realities.
“To be honest, for the last few years, we could have had fixed-price offerings, and there wouldn’t have been much difference,” says one banker.
Regain its sheen
The Guotai Junan approach should not be a template, clearly: true price discovery and conventional ranges will be extremely important if the market is to regain something of an institutional sheen.
What was important, though, was that the book featured far more long-only, international institutional money than has become typical in these deals, with those buyers feeling that the fixed price was palatable after detailed analysis.
If that continues, we might see liquidity return to a market that is enormous but scarcely trades relative to its size because so many multi-billion dollar deals have really been taken down by a glut of cornerstones, with a low percentage of the stock floating freely.
“If we can come to a market which is less attractive to cornerstones, there will be more market-driven pricing and more liquidity,” a banker says.
So, even if Guotai Junan isn’t a role model, it may at least move things along.
It is odd, though, that if the situation is finally going to improve in Hong Kong, it doesn’t appear to have had much to do with Hong Kong’s own exchange or regulators, but instead changing attitudes on the part of Safe about capital movement.
Cornerstoning and its associated effects “have clearly been a problem for the exchange, but they have always taken comfort in the fact that IPO volumes in Hong Kong are greater than anywhere else,” says a banker. “It is a banner international listing venue. But the reality is, it isn’t institutional at all.”