Huabao and Renhe tumble after sell-downs

Sharp declines in the share prices of two Hong Kong-listed companies that were the subject of sell-downs by existing shareholders late last week shows that, irrespective of the stockmarket recovery in March and two successful IPOs over the past week, investor sentiment is still cautious. Investors may be willing to buy shares at a deep discount, but a key reason for many of them to do so seems to be the opportunity to make short-term profit.

Huabao International Holdings was first out with a placement of HK$1.16 billion ($149 million) on Thursday night as chairman Chu Lam Yiu sold a small part of her holdings in response to what was referred to as reverse inquiries from investors who were finding it difficult to buy shares in bulk in the market. The deal was upsized by 50% suggesting there was good demand, but a 17% drop in the share price on Friday -- versus a 12.5% placement discount -- put into question the quality of some of that demand.

It was followed on Friday by a HK$680 million ($87 million) sell-down in Renhe Commercial Holdings by three existing shareholders. The deal, which was arranged by Morgan Stanley and completed during the lunchtime break, was no doubt inspired by a similar sale by five shareholders the previous week that went well. The latest sale was priced at an 8.6% discount after a 30-minute bookbuilding, and according to a source, the deal was fully placed. However, rival bankers and some investors questioned whether that was really the case after a few smaller investors said they had received a 100% allocation. It was also believed that the earlier Renhe placement, which was priced a couple of cents lower, had exhausted much of the current institutional demand for this stock -- or the bookrunners would have used the 21% upsize option on that deal.

Be that as it may, the 11% drop in the share price during afternoon trading indicated that not all the buyers were in it for the long-term. Having already fallen in the morning session, Renhe lost 15% during the course of the day and finished 2.9% below the placement price.

Placement activity in Hong Kong has shown signs of picking up over the past couple of weeks, and while this suggests some confidence from the arranging banks that investors are ready to buy again, it also suggests that existing shareholders are eager to take advantage of the recent recovery to secure profits, or perhaps to trim down or exit their holdings at a more reasonable level. Hong Kong was awash with rumours of other placements on Friday, including a potential sale of shares in Industrial & Commercial Bank of China (ICBC), but nothing came of those.

Hong Kong's Hang Seng Index has gained 28.2% since it hit a 2009 low of 11,344 points on March 9 and is currently up 1% this year. It finished 0.2% higher at 14,545 points on Friday after the Group of 20 countries, in a somewhat surprising show of unity to battle the financial crisis, said they intend to provide an additional $1.1 trillion to the International Monetary Fund for the support of global trade finance.

One indication that investor sentiment is still a bit wobbly is the fact that most of the recent placements have required discounts in the double digits -- the notable exception being the sale by Morgan Stanley's private equity arm of $72.8 million worth of shares in sportswear designer and retailer China Dongxiang Group earlier last week, which was done at a 4.8% discount. The deals have also been small in dollar terms.

The Huabao placement was, however, sizeable in relative terms, with the shares on offer accounting for about 37 days worth of trading volume based on data for the past six months. The deal, which was arranged by Deutsche Bank, comprised 127 million shares with an option to sell an additional 63.5 million shares in case of demand. The upsize option was exercised in full and the price was fixed just below the mid-point of the HK$5.98 to HK$6.28 range at HK$6.10. This gave a discount of 12.5% versus Thursday's close of HK$6.97.

Huabao is a tobacco flavouring company with a market cap of $2.3 billion, and is viewed as a good defensive consumption sector stock, something which is further emphasised by its low gearing and HK$1 billion cash position. It is a favourite pick in the sector and of the 15 analysts who cover the stock, 11 rate it a "buy" while two analysts view it as a "hold" and two as a "sell".

The stock has doubled since late October when it hit a low of HK$3.40 and Thursday's close was only 12.2% below its 2008 high of HK$7.94 from late May. However, part of the reason for the strong gains, say one source, is the fact that there isn't much stock available to buy. The free-float was about 37% before this transaction, but much of that is held for the long-term, meaning it is difficult for new investors to acquire shares in size without pushing up the price.

Including the upsize option, Thursday's sale accounted for 6.2% of the outstanding share capital and about 16.6% of the free-float.

More than 60 accounts bought into the deal and the order book was multiple times covered. About 65% of the demand was estimated to have come from Asia, while about 30% came from the US. The reverse inquiries indicate that part of the demand at least came from long-term buyers, while the sharp drop in the share price the following day offers clear proof that the book also included a number of opportunistic buyers taking advantage of the discount.

That in mind, the tighter discount on the Renhe placement -- not just against the Huabao deal but against the previous Renhe deal as well -- could have been part of the reason why investors may have been less keen on that offering. Observers say that on stock like Renhe, which cannot be sold short and there is no equivalent company that can be used as a hedge, most hedge funds would have wanted at least a double-digit discount to participate.

The three shareholders offered 400 million shares in the Chinese developer of underground shopping malls at a discount of 7.5% to 9.7% versus the Friday morning close of HK$1.86, which translated into a price range of HK$1.68 to HK$1.72. It was priced at HK$1.70 for an 8.6% discount, which compares with the 15.2% discount on the previous sell-down on March 26. That initial placement, which was the first time international institutions really paid attention to the stock since the October IPO was largely bought by Chinese corporates and individuals (often referred to as relationship accounts or "friends and family") was priced at HK$1.68.

The share price dropped 11.6% the day after the first placement and hit a low of HK$1.70 the following day, but had recovered since then and, on Thursday, closed at HK$1.94, four cents below the HK$1.98 where it traded before that first deal. The March placement was arranged by BOC International and UBS, which were also joint bookrunners on the IPO together with Morgan Stanley and HSBC.

Renhe falls somewhere in between the commercial real estate and retail sectors. It operates shopping malls, primarily for clothing and accessories, but doesn't get a percentage of the sales generated by its tenants. At the same time, it isn't legally classified as a developer since all its malls are built as civil air defence shelters and as a result the company is exempted from land use right premiums, land appreciation tax and property tax -- giving it a distinct advantage over the traditional developers of commercial properties. It doesn't own any land bank, but rather has operational rights for the facilities it builds for 40 years.

Among the key investment arguments at the time of the IPO were the company's high earnings growth and impressive margins. By placing its malls underground, Renhe is also able to gain access to prime commercial areas in cities where land supply above ground is limited, giving it another leg up on the operators of traditional malls.