Asian stock markets may have re-discovered some positive momentum after a rocky 2018, but many issuers and investors are increasingly turning to off-market deals to boost valuations and longer-term returns in the face of ongoing volatility.
There are two clear trends, both of which benefit bigger investors with better broker relationships and access to non-public information.
Firstly, there is a far more active secondary market for blocks of shares before a company lists thanks to Asia’s private equity market, which has already doubled in size over the past decade and continues to expand rapidly.
Off-market block trades among listed stocks have also picked up, especially in Hong Kong, where public equity markets often do not operate as smoothly as many bankers and investors would like.
Hong Kong’s habit of reducing IPO liquidity by stuffing paper into cornerstone tranches weighs on a stock whenever its lock-up comes close to expiry. This overhang has got all the heavier in recent years thanks to the additional pressure created by a growing army of private equity investors hoping to exit as well.
As a result, league table data can end up misrepresenting how active Asian equity capital markets are. For example, Dealogic data portrays a very sluggish start to 2019.
On the surface, this is hardly surprising given how volatile and difficult stock markets were during the latter months of 2018, particularly with IPO issuers forced to adopt a wait and see approach.
Where secondary market trades are concerned, there were only two issues in Hong Kong above $50 million in size in January: a $434 million follow-on offering for Longfor Properties and a $250 million top up placement for Country Garden. By contrast, January 2018 saw almost $5.5 billion of business.
But bankers believe that as much volume is currently being conducted off-market as on. According to Tucker Highfield, Bank of America Merrill Lynch’s co-head of Asia Pacific equity capital markets, around $1 billion in $50 million plus off-market equity blocks priced during the course of the month.
The bulk of the paper that priced in January came from Xiaomi Corp, whose six-month IPO lock-up expired on January 9. In addition to the HK$2.18 billion ($278 million) block of shares that was disclosed, a further $500 million of stock was sold off-market and fell below the disclosure threshold.
“There’s a lot of focus on the secondary side right now, particularly towards companies that have lock-ups coming due,” Highfield commented.
Next in line was Nasdaq-listed Pinduoduo, whose lock-up expired on January 22. A 59.6% share price performance after it listed prompted the company to announce what looked like an opportunistic 37 million new ADS unit follow-on on February 5.
A group of pre-IPO shareholders also joined the deal, which priced on February 8, opting to use the more efficient US public markets to sell 14.8 million ADS units. Together the two groupings raised $1.375 billion.
As SmartKarma insight provider Arun George comments, the lock-up expiry presented “an opportunity for pre-IPO shareholders to crystallise their enormous returns". In the case of Banyan Partners, he calculates that amounts to a return of 22,500% based on the shares it purchased during the Series A-2 funding round in 2015.
Analysts warn that Hong Kong-listed China Tower Corp will be next, as 7.74 billion cornerstone shares have come free since the lock-up expired on February 8. According to a recent research report by KGI Securities, “the market is concerned that these investors may reduce their holdings during current share price strength.”
At the time of its HK$54 billion ($6.88 billion) IPO last August, China Tower seemed very old school compared to online ticketing agency Meituan Dianping, which raised HK$33.1 billion ($4.2 billion) from its IPO one month later.
But shares in China Tower have gone up 40.1% since its listing thanks to positive 5G-related sentiment and is currently trading at 33 times forecast 2020 earnings. The 7.74 billion shares are valued at $1.75 billion as of February 11's close. (HK$1.26)
By contrast, Meituan Dianping’s share price has halved over the same period thanks to the tech sector bust and some of its pre-IPO investors may decide to cut their losses when the lock-up expires on March 21. At IPO, it distributed 170 million cornerstone shares, which are currently valued at $1.03 billion as of February 11.
Hong Kong-listed Haidilao International’s lock-up will also expire on March 26, releasing 165 million cornerstone shares according to S&P Global Market Intelligence data. They are worth $430.9 million as of February 11.
Highfield told FinanceAsia: “The block market is likely to remain active. A lot of prospective sellers aren’t feeling confident that market sentiment will get any stronger over the course of the year so the temptation to sell now is high.”
SECONDARY MARKET PRIVATE EQUITY
Yet bankers say that investors are actively engaged right now, particularly hedge funds looking to play the volatility and private banking clients with money to invest.
Both types of investors like off-market trades in Hong Kong because of the simplicity and the control they gain compared to the public equity markets where they are never certain how many “friends and family” are involved.
One private banker also told FinanceAsia that many of his clients are becoming more interested in pre-IPO blocks. “That’s because they don’t think the public equity markets are going to perform well over the next couple of years and they don’t have to mark these kind of deals to market,” he explained.
Highfield agrees. “These kind of deals enable investors to value companies on a longer-term IRR (internal rate of return),” he commented.
Johnson Chui, head of Asia Pacific equity capital markets at Credit Suisse, says that sellers are often private equity and other private company-focused funds that need to vest, or simply want to re-invest funds somewhere fresh.
“It’s a part of our business that’s been growing for the past couple of years, with our strong private banking platform generates a lot of the flow,” he commented.
It is the kind of business that other banks are keen to build up too. One prominent example is HSBC, which, so far, has never been able to build up an equity capital markets platform that comes anywhere close to matching its dominant DCM one.
However, under its new CEO, John Flint, the bank has placed a heavy emphasis on wealth management and is some aspects is now at the front of the pack on a broader definition of what equity stands for.
For example, a number of banks offer Asian private banking clients access to fund of private equity fund investments. But those funds typically target primary private equity opportunities.
HSBC's Vision Fund is unusual because it is mixed: 65% primary private equity and 35% secondary private equity blocks. This year will also be the first time that private banking clients can invest in it alongside institutional ones.
The short duration of secondary private equity combined with the sector's illiquidity premium should theoretically generate higher returns for investors. In general, however, valuations currently remain higher on the private equity side compared to public markets.
BAML’s Highfield believes they will catch up.
“The correction in the public markets is always very instantaneous,” he said. “There’s a lag effect for private equity.”
Yet, this may not become immediately apparent. Issuers may well opt for smaller funding rounds at the same valuation rather than larger ones at a lower valuation.
“There’s always more sensitivity about valuations,” Highfield continued. “But companies, which need to raise capital will start accepting lower ones.”
Ricky Tang, Schroders deputy head of multi-asset products for North Asia, also agrees that 2019 is shaping up to be a volatile year and expects consensus earnings to remain weak.
“Estimates could be revised down as analysts tend to start the year with a positive view about earnings,” he said. “We still think there’s room for earnings expectations to adjust lower.”
Schroders has notched down its risk appetite to medium compared to where it was last summer.
One reason is due to the US Federal Reserve, which may become less dovish if global growth does not slow as much as consensus forecasts. However, Tang also highlights the risk of a US recession, which is increasingly pre-occupying many fund managers’ minds.
“Six months ago, our risk assessment was still green,” he told FinanceAsia. “Now a number of medium-term indicators are starting to turn red.”
But he believes China is becoming more attractive for medium-term investors.
“Some of the domestically-focused tech names are starting to look interesting,” he noted. “Where one year ago they were trading at 50 times forward earnings, it’s now more like 20 times.”
Tang believes the Chinese economy will not experience a hard landing. He also expects the main form of stimulus to come from central government tax cuts, as they will directly benefit companies' bottom line.
Furthermore, he is positive about the rest of the region on the grounds that dollar strength has run its course. This has already been reflected in primary market issuance.
The Philippines in particular has sprung back to life after a lacklustre 2018, which saw the Philippines Stock Exchange PSEi Index fall 12.76%.
They came into a market with strong momentum. The PSEi Index rose 9.08%, during the course of the month, making it the region’s second best performer after the Hang Seng China Enterprises Index, which was up 9.28%.
In terms of stock selection, Tang suggests investors opt for stocks in the middle of the dividend to growth spectrum. “Higher yielding names have got quite expensive,” he said. “It’s better to play in the middle. We like selected materials companies and some Reits.”
During the first quarter of 2019, this is likely to include India’s first Reit: a $1 billion plus commercial office space deal from Blackstone and India’s Embassy Group.
It will be coming into a market where confidence remains balanced on a knife-edge. And while public equity market issuance will start to pick up again after Chinese New Year, market participants believe off-market trades will continue to gain a larger share over a much longer time horizon.
Tang is one who believes that 2019 will end up as a positive year overall, but it will not provide investors with an easy ride.
“We expect 2019 to be a positive year,” he concluded. “But the path to achieve that could be quite wild. Be prepared for more volatility ahead.”