One of the most closely watched, eagerly anticipated and largest initial public offerings in Hong Kong’s history kicked off on Wednesday after Alibaba opened the institutional order book for its secondary market listing.
The indicative $13.4 billion deal (post greenshoe) is on course to become the Territory largest-ever corporate IPO and world’s largest secondary market listing in a new jurisdiction.
This is a jumbo that has had a much longer gestation period than its animal namesake and even the company itself anticipated when it first contemplated accessing the public equity markets five years ago. Alibaba officials said as much during a global conference call with institutional investors on Wednesday.
Michael Yao, the China e-commerce group’s head of corporate finance, told fund managers that Alibaba had initially considered a Hong Kong IPO back in 2014 before eventually listing on the New York Stock Exchange (NYSE) that September. What has changed since then is Hong Kong’s decision to allow companies with weighted voting rights to float their shares in the Territory as well.
But much else across the globe has changed during that intervening period too. It makes this deal one that is replete with symbolism on any number of levels.
Perhaps most important of all is the much-needed confidence boost the IPO is likely to deliver to Hong Kong following months of increasingly violent street protests. Alibaba’s decision to plough ahead now, after hesitating in the summer, says a great deal about how that unrest has become the new normal.
Its deal is also coming at a time when US-listed Chinese companies are well aware that they need an insurance policy and escape valve in case proposed legislation comes into effect, which will require them either to open up their books to US government audit inspections, or face delisting. If Alibaba is successful, all eyes will turn to highly liquid, solely US-listed Chinese stocks including Baidu, JD.com, NetEase and Pinduoduo to see whether they decide to follow its lead.
WHY CHOOSE HONG KONG?
Yao acknowledged Hong Kong’s “strategic importance” to Alibaba on the conference call and told investors it wanted to list in the Territory for three main reasons.
Firstly, he said Alibaba wants its digital eco-system users to be able to invest in its growth. Secondly, it is keen to diversify its funding sources so it can “tap substantial new capital pools in Asia.”
And thirdly, it wants to provide investors with “near round-the-clock market access” to its shares. This latter point will be particularly attractive to institutional investors.
They remain keenly aware of how exposed they are to China risk while US markets are shut during the Asian trading day. Key to this 24/7 trading activity operating smoothly will be whether there is a good-enough balance between the two liquidity pools in the US and Hong Kong, which will be separate but fungible.
Yao noted that the company and its financial advisors had thought long and hard about how much of the group’s equity capital to offer in Hong Kong.
He said that the group did not want to dilute existing shareholders overly. As such, the 500 million primary share deal (plus 75 million share greenshoe) will represent 2.76% of Alibaba’s outstanding equity. One common share equals eight American Depositary Receipts (ADRs).
But Yao added that Alibaba was also conscious of needing to create a sizeable enough float to avoid Hong Kong being crushed by the weight of the group’s trading volume in New York. Alibaba’s three-month average daily US trading volume stands at $2.4 billion.
Hong Kong trading volumes need to become the mouse that roars. Alibaba will be keen to avoid what happened to Chinese biotech company, BeiGene.
In August last year, BeiGene completed a secondary listing in Hong Kong to complement its existing US Nasdaq listing. It offered 8.58% of its total equity in the Territory, but trading volumes have leached away to the US. It is a rare day when the former trades more than 1% of the latter’s volume.
Can Alibaba avoid the same fate? It seems highly likely for a number of reasons, not least the fact that it is such an iconic and well-known brand.
Over the short-term, its trading prospects should also be boosted by almost certainly qualifying for fast-tracking into the Hang Seng Composite Index within the first 10 days of trading.
On the medium-term horizon, it should also be admitted into the Shenzhen and Shanghai Stock Connect programmes. Yao told global investors that Alibaba was “hopeful” that the regulator would grant permission.
Under new rules, unveiled last month, the earliest this could happen would be in June next year.
DISCOUNTED PRICING?
What does all this mean for pricing? Institutions will certainly be hoping that the group decides to price the Hong Kong offering at a discount to US trading levels, no matter how oversubscribed the order book gets.
A financial markets pop would certainly cheer up Hong Kong-based investors that have had to get used to hearing a far more distressing alternative when they leave their offices.
Investment bankers said the deal is initially being pre-marketed at up to a 5% discount. This, however, will almost certainly be rapidly narrowed down to a much slimmer margin over the coming few days.
Research conducted by Global Equity Research’s Arun George shows that most stocks, which have a dual Hong Kong and New York listing, trade at a very slight premium in Hong Kong. Writing on Smartkarma, he notes there are two main exceptions: BeiGene and Manulife Financial Corp, which average a 0.33% discount.
He attributes this to their lower trading volumes in Hong Kong and says that: “trading volumes play a role in the HK-ADR premium/(discount).” This leads him to conclude that he would expect Alibaba’s H shares to “trade at a discount to the ADRs.”
In terms of share price performance, Alibaba has risen 32.33% year-to-date and was trading Wednesday at $181.39 in New York. Bankers do not believe the stock will come under heavy short selling pressure this week since many existing US holders will be conscious that allocations for the Hong Kong IPO will be both uncertain and tight.
Hong Kong retail investors, meanwhile, are being offered 2.5% of the new equity deal. There will be clawbacks to a maximum of 10% if the deal is more than 20 times subscribed.
This seems highly likely based on a spike in Hibor rates to a high of 2.64% on Wednesday as local citizens hoarded cash to apply for the stock.
THE ONLY WAY IS UP?
When it comes to future share price performance, Alibaba remains on the buy list of the investment banking community.
At the high end of the range are banks like Goldman Sachs, HSBC and BOCI with respective target prices of $253, $247 and $243. At the lower end are CICC, Morgan Stanley and China Merchants on $200, $215 and $218.
In a recent research report, Goldman Sachs highlighted that Alibaba is trading two standard deviations below its historical average and that the Tencent’s price-to-earnings (P/E) premium over Alibaba has continued to widen despite the latter’s more visible revenue growth.
One of the stock’s strongest tailwinds is likely to come from the success of Alibaba’s 11th 11:11 Global Shopping Singles Day, which generated gross merchandise value (GMV) of Rmb268.4 billion ($38.3 billion) this year.
Speaking on the global conference call, Alibaba chief financial officer Maggie Wu told investors that only 90 countries, of the 200 she checked, had GDP levels higher than this.
One thing officials were keen to emphasise is that Alibaba does not really need the funds it is raising and the equity offering will not change its current investment plans. During its recent quarterly results, it reported free cash flow totalling $17 billion, for example.
In a recent research report, HSBC said that Alibaba’s “measured investment approach should boost investor confidence on it’s long-term competitive positioning”.
Alibaba officials said that one of the most frequent questions they are asked about is consumer confidence. They pointed out that while China’s GDP growth has weakened, online retail growth remains extremely strong.
Financial analysts note that online retail sales growth decelerated 15% year-on-year during the September 2019 quarter compared to 17% during the June quarter. Nearly every single one, however, is bullish about Alibaba’s ability to: enhance user engagement, cross-sell across platforms, expand overseas and penetrate into less developed parts of China where user penetration is 40% of internet users compared to 85% in developed regions.
If everything now goes to plan, bookbuilding for the institutional tranche will close on November 19. The Hong Kong public offering will run from November 15 to 20.
Pricing will take place before the US open on November 20, with listing scheduled for November 26. It will trade under stock code 9988, a lucky combination in Chinese.
Joint sponsors are CICC and Credit Suisse, with joint global co-ordinators comprising Citi, JP Morgan and Morgan Stanley, plus HSBC and ICBCI as joint bookrunners.
