Big listings in the pipeline for this year could put the “pop” back into Hong Kong’s IPO market
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Hong Kong has been the world’s leading financial market over the past two years for raising capital through initial public offerings, and the local finance industry is optimistic the feat can be repeated in 2017.
While this will be music to the ears of bankers, lawyers and stockbrokers, the same cannot necessarily be said for the investors expected to buy these shares.
An examination of the performance of last year’s 84 new issues on the Hong Kong stock exchange’s main board shows that only just over half of them are currently trading above their listing price. Still, this is better than the class of 2015, where 70 per cent of the new issues are still under water. Admittedly the Hang Seng Index slumped by 20 per cent that year but it reinforces the point that participating in IPOs is an inherently risky business. Indeed, one veteran fund manager likened it to selecting horses at Happy Valley.
Andrew Sullivan, managing director of sales trading at Haitong International Securities, says that institutions participate in most IPOs on the basis that they might make money from six or seven out of every 10. But this is hardly an attractive proposition for individual investors.
“Gone are the days when 99 per cent of Hong Kong IPOs jumped at least 10 per cent on the first day because they were all heavily oversubscribed. It’s no longer an easy market for investors,”
- Andrew Sullivan, managing director of sales trading at Haitong International Securities
He says last year’s IPOs comprised mainly small to medium-sized enterprises where a significant part of the allocation of new shares went to friends, family and employers as a kind of bonus. “Most of these people flipped the shares on the first day and the share price collapsed.
“You have to look for companies with real demand and real people behind these new issues,” he adds. “You need, for example, to know how many hedge funds are involved, how many long funds, and whether they are involved at the strike price or below. It’s not just a matter of taking a punt.”
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Nevertheless, the belief that IPOs offer the opportunity to get in on the ground floor of the next Microsoft, Google, Apple or Amazon is an enduring one.
But in reality this is rarely the case. An IPO may represent the first opportunity for individual investors to get involved, but it may also be the fourth or fifth round of funding for institutional investors who entered earlier and at lower prices. For these investors, IPOs are often an opportunity to exit their investment, which is particularly common with tech stocks.
Do Your Homework
Before getting into any detailed due diligence on the company it is worth establishing where the IPO funds are going and the stated reasons for raising capital. If the funds are going back to the owners of the company, this is a danger signal as it means they are cashing out. If the funds are being used for a defined purpose, this is generally a positive sign. If there is no indication what the funds are being used for, that’s also a negative sign. And if the company is being groomed for an IPO by a private equity firm or similar, it’s often a danger signal since it is cashing out, and private equity groups are notorious for overpricing their holdings.
Investors also need to be wary of the “cornerstone” factor in the Hong Kong IPO market. This is the practice of selling large blocks of shares ahead of the IPO to friendly investors who are then obliged to hold them for six months. Furthermore, the typical Chinese cornerstone investor holds the stake not so much because it has an interest in the business or wants to make a capital gain but as a favour or for strategic reasons to help in completing the deal. As a result, they take away liquidity at the initial stages, helping to drive up the price of the stock. And when they emerge from the lock-up period and sell, this can deflate the price.
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Indeed, there is a sense that the Hong Kong market favours issuers over investors. First-day gains in US markets are generally higher than in Hong Kong.
The best opening debut in Hong Kong last year was from the mainland Chinese stockbroker GF Securities, which rose 35 per cent on its first day. Even the miserly 0.32 per cent first-day rise by China Huarong Asset Management made it into the 10 best first-day performances in Hong Kong last year. GF’s first-day performance would have ranked it fifth among US IPOs last year.
These problems are made worse, according to investment bankers, by demands by Chinese issuers for high IPO prices, which further deflates the aftermarket. That said, mainland companies have been a huge source of business for the Hong Kong stock market in the past decade and accounted for about 70 per cent of capital raised last year. Financial services company PwC forecasts that mainland companies will dominate Hong Kong’s IPO market again this year. Of particular interest are the big mainland Chinese technology and fintech start-ups that Hong Kong hopes it will be able to attract.
On the Cards
The most interesting of these is the huge Ant Financial, which owns Alipay, China’s largest online payment system. Ant has been valued at more than US$60 billion, making it almost as big as Bank of Communications, China’s fifth-largest bank. It has more than 400 million users and last year processed more than US$1.9 trillion, according to a study of China’s fintech industry by EY and DBS. If it lists in Hong Kong it will be the territory’s biggest listing since 2010, when Agricultural Bank of China went public and raised US$22.1 billion.
Another possibility is Shanghai Lujiazui International Financial Asset Exchange, otherwise known as Lufax, which is China’s largest peer-to peer online lending platform, matching individuals to China’s largely unbanked small and medium enterprises. Backed by Guotai Junan Securities, Minsheng Bank and Bank of China, Lufax is valued at about US$19 billion. According to Reuters the company is preparing a Hong Kong listing that could raise US$5 billion. Another listing candidate is Zhong An Insurance, which is valued at about US$8 billion and is backed by Tencent, Alibaba and Ping An.
China’s fintech sector is the biggest and fastest growing in the world. Should any of these three list in Hong Kong they could well put some of the “pop” back into the IPO market.