Volatility takes shine off golden age for Asian follow-ons

One of the sure signs of an ageing bull market is when follow-on equity deals start picking up steam as sellers try to time the top of the market.

Just such a pattern started to take shape in Asia at the beginning of 2018 as issuance volumes rose.

The region’s equity markets appeared to be heading for a golden period of strong secondary market issuance matched by solid momentum-driven demand. A win-win situation for both the buy and sell side.

Valuations were high. But in Hong Kong at least, equity strategists argued they would be buttressed by accelerating Southbound flows.

Yet as the first quarter rolled on, activity did not pan out quite as anyone had expected. The golden period lasted for less than a month and it had a sting in its tail, which is reverberating into the second quarter and beyond.

Secondary market performance has been mixed to say the least thanks to the volatility, which returned with a vengeance during February as investors worried about rate hikes and trade wars.

Those concerns have only picked up pace at the beginning of the second quarter as the US and China engage in tit-for-tat tariffs.

Equity market volatility and investor nervousness could prove a toxic brew. Hong Kong-based regional equity syndicate heads believe it could play out one of two ways, but on balance remain optimistic.

No-one doubts that if volatility becomes too severe, or investors become too nervous, the two will crimp issuance since there is a limit to how far sellers will be willing to widen discounts. But volatility, in moderation, could be beneficial if it prompts a rethink by issuers who had previously been waiting for the next leg of the market rally.

“Sometimes a bit of a jolt serves as a good wake-up call,” said David Binnion, Goldman Sachs’ head of equity capital markets distribution and risk for Asia. “Last year, with potential sellers feeling that markets would carry on going up forever, there was a lack of urgency to divest stocks and hence there wasn't as much activity as we might have expected."

But will they find a willing audience, especially if investors have fundamental concerns about the direction markets are ultimately heading in? Tucker Highfield, head of Asia Pacific equity syndicate at Credit Suisse, remains upbeat too.

“Ironically, volatility could have a positive impact, although discounts may have to widen a little bit if it picks up,” he said.

As markets drop back towards their five-year averages, investors may believe it gives them a potential re-entry point.

Key will be how they interpret fourth quarter earnings. Most Asian companies have almost finished reporting, although the next Indian earnings season kicks off from next week.

So far, results have not bolstered arguments that the Asian earnings cycle is still on a strong upswing.

At the end of March, Morgan Stanley noted that 85% of the MSCI EM universe had reported. But it highlighted that companies have missed consensus net income estimates for the fourth quarter of 2017 by 0.5% in aggregate.

“This is the first earnings miss after six straight quarters of earnings beats in EM and APxJ [Asia-Pacific ex-Japan],” it stated.

GREATER CHINA

The bright spot remains China, where Morgan Stanley said that, overall, Chinese companies beat net income estimates by 2.7%.

China’s economic resilience has also underpinned the Hong Kong’s first quarter follow-on trades, which have generally outperformed those from the rest of the region.

This is partly a reflection of the underlying market’s performance. The Hang Seng China Enterprises Index (HSCEI), for example, was still up 3.11% year-to-date as of Monday’s close. It was one of the few Asian indices to end the first quarter in positive territory.

But investors' positive reception to the first quarter’s biggest deals also reflects the fact they were largely about raising new money, rather than existing investors cashing out.

Four out of Hong Kong’s five biggest deals were about expansion: Country Garden, China Hongqiao (which also included a divestment), WuXi Biologics and China Jinmao. They respectively raised $1 billion, $798 million, $509 million and $426 million.

As of Monday's close, two were below their execution price and two above.

Country Garden and China Hongqiao are down 7.77% and 8.65%% from their execution prices in mid-January. China Jinmao and WuXi Biologics are respectively 18.9% and 19% up from theirs in mid-January and late-March respectively.

First quarter activity from Hong Kong has also been noticeably stronger than 2017, with five $500 million plus deals compared to just one for China CITIC Bank last year. They were led by Tencent’s mammoth $9 billion offering on March 22.  

If ever a deal symbolised the first quarter it was this one.

It was large (record-breaking in fact). But South African internet conglomerate Naspers could hardly have picked a worse day to launch it; butting up against the volatility caused by US President Donald Trump's administration announcing its $50 billion trade tariffs against China.

It meant the deal had to be priced with a higher than expected discount of 7.83%. But it still attracted an outsized $20 billion order book after investors concluded the 2% divestment was driven by internal reasons rather than because Naspers believed Tencent’s valuation had topped out.

As a result, Tencent’s share price has just about managed to hold its own, staying above issue price for most of the time and closing Monday up 1.2% from its HK$405 execution price.

The first quarter’s other standout deal came from Nasdaq-listed BeiGene, which also hails from investors' favoured biotech sector.

In mid-January, the company raised $800 million for expansion at a slim 1.59% discount to close. As of Monday’s close, the stock was up 64.6% above its US$101 execution price - the quarter's best performing benchmark secondary market trade.

Goldman was one of BeiGene’s lead managers and Binnion says it is a good example of the kind of company investors are looking for.

“We’re not in an environment where investors are tripping over themselves to get into deals blindly,” he said. “But they are looking for good access points for liquidity and they’re definitely still moving to address underweight positioning in China.”

Credit Suisse’s Tucker also highlights two other trends, which could play well into the second and third quarters.

“There’s a pipeline of pre-IPO investors looking to divest, but it is in real companies with good medium-term earnings outlooks,” he explained.

“Secondly, investors are still very keen on certain sectors like tech. Valuations may seem high but it’s nothing compared to the hyper-competitive private equity market where there’s a lot of cash vying for deals.”

SOUTH KOREA

At the other end of the scale is South Korea, a country that many equity strategists currently underweight.

The worst performing secondary market deals are led by Temasek’s twin selldown in Celltrion Inc and Celltrion Healthcare on March 6. As of Monday, the $699 million and $292 million placements were respectively down 9.2% and 5.5% from their execution price despite the fact they carried fairly wide discounts by Korean standards (9% to close).

One reason is because they remain at the top of the market's short-selling list after the US Food & Drug Administration issued a warning letter about some of Celltrion's manufacturing processes earlier this year.

And as Morgan Stanley noted in its end of March wrap, Korea has also reported the biggest earnings miss among the MSCI universe. At the end of the month, 92% of companies had reported and 63% had missed consensus net income estimates.

As of Monday's close, the Kospi was down 0.95%. Over the past three trading sessions, it has re-bounded 1.5% as investors bet that Asia may be experiencing a correction rather than a bear market.

But South Korea remains one of the few Asian countries trading below its five-year averages: at about 8.8 times current year consensus forecasts vs a 9.4 times five-year average.

Equity strategists generally do not believe this is likely to change given recent moves towards greater trade protectionism do not play well in a country with such a large export focus.

ASEAN

Issuance from the rest of Asia has been a bright spot in terms of size, but less so in terms of performance.

There has been a big pick-up where the former is concerned. Overall, Dealogic data shows a 48.1% uptick in first quarter issuance for Asia ex-Japan, ex-China. 

In 2017, there was just one secondary deal over $150 million, for BDO Unibank. This year there have been six, from Thailand (Siam Makro plus Land and Houses), the Philippines (Ayala Corp and Robinsons Land), Malaysia (SP Setia) and Vietnam (Vincom Retail).

However, secondary market performance has been mixed in line with underlying markets.

The Philippines market has been Asia's worst performer year-to-date, with the PSEi Index down 7.16% to Monday's close.

This did not help Ayala Corp's $153 million issue from mid-March, which priced with a 7.53% discount. As of Monday's close, it was trading 1.7% below execution price.

Robinson Land's $151 million rights offering from mid-February has fared slightly better and is above its ex-rights price.

In general, equity strategists say the Philippines market has been weighed down by the combination of a falling peso and heavy rights issuance from the banking sector. However, valuations have now fallen below their five-year average in terms of current year P/E multiples (17.9 times compared to 18.3 times five-year average).

Foreign investors turned net sellers in February. But in a recent research report, Credit Suisse said the Philippines' may benefit if its domestically-driven economy is seen as a safe haven in a world rocked by trade wars.

This may be indicative of a wider trend, in which investors use lower valuations as a re-entry point.

Where Thailand and Vietnam are concerned, it is about rarity value. Both Binnion and Highfield say it is pleasing to see activity picking up from both markets given how low volumes have been in the past.

Vincom's $199 million deal from early February has performed particularly well, up 12% from its VND 47,750 execution price as of Monday. Thailand is slightly more mixed, with Siam Makro up 5.1% from its Bt44 execution price in late-March, while Land & Houses is flat to its Bt10.9 issue price in early-February.

But uncertainty is unlikely to go away. Morgan Stanley recently underlined the prevailing mood when it drew parallels with the end cycle performance of 2000. “That was a year of strong global growth but tightening monetary policy and a very choppy market performance given high valuations,” it concluded.