Bank of China prices world's sixth largest IPO close to top

Investors ignore tumbling equity markets and Chinese signals of more lending curbs and pile into offering, citing favourable valuations.

Having just pulled off the world's sixth largest IPO ever, Bank of China decided to give investors an extra five cents of potential upside by pricing its offer at HK$2.95 per share. That was just off the top end of the HK$2.50 to HK$3 price range, and led to a total deal size of $9.73 billion.

According to sources the below top-end pricing wasn't necessary since the book was well covered with very limited price sensitivity, but the gesture was believed to have been make in recognition of the sharp correction in global markets over the past week.

From the perspective of the history books it will make little difference as the deal could still end up surpassing Telstra and AT&T Wireless to become the fourth largest IPO globally if the 15% greenshoe is exercised in full, allowing it to raise $11.19 billion in total. Whether or not demand in the secondary market will be strong enough to see that happen will depend to some extend on what happens in the market between now and June 1 when the shares are due to list.

Given how investors seemingly had no problem ignoring a 7.1% drop in the Hang Seng Index during the bookbuilding period, however, investors say it seems highly unlikely confidence will falter once the shares start trading û unless of course the bottom totally falls out of global equity markets.

BOC's offering is already the largest IPO by a Chinese company, edging ahead of China Construction Bank's $9.2 billion share sale in October last year. However, BOC is widely expected to concede that spot when Industrial & Commercial Bank of China decides to brave the market, potentially in the third quarter of this year.

BOC's IPO, which comprised 10.5% of its enlarged share capital or 25.6 billion new H shares, was jointly arranged by Bank of China International, Goldman Sachs and UBS.

The final price values BOC at 2.18 times its estimated 2006 book value, which compares with 2.43 times for China Construction Bank, according to people familiar with the offering. Bank of Communications, which is only about one third the size of BOC in terms of market capitalisation, trades at about 2.65 times its forward book value.

ôThe stock is cheaper than CCB, ChinaÆs economy is growing fast, benchmark-related funds wonÆt be able to get enough shares and so far most big cap China stocks have done well after their Hong Kong IPOs,ö says Kingston Lee, a fund manager with Nomura Asset Management, on the question of why investors were so keen on ChinaÆs number two lender.

ôEven in the current market environment, the chance that it will fall below its offer price seems quite small,ö he says.

Given its size, it is widely believed that BOC will be fast-tracked into Morgan Stanley Capital InternationalÆs index series, which would fuel automatic demand from funds tracking or benchmarking themselves against these indices.

Even without confirmation that this will be the case though, the total offering was about 12 times subscribed, according to sources familiar with the deal, which translates into more than $105 billion worth of demand at the final price. The fact this came at a time when emerging markets as a group took their biggest dive in eight years and China flagged a need for new austerity measures to curb lending, shows investors do believe China will be able to manage its rapid economic expansion - and set the scene for healthy corporate earnings growth and increasing personal wealth.

Institutional investors ended up ordering about 20 times the amount of shares available to them after deducting the portions set aside for retail investors, 12 cornerstone investors and Singapore government investment vehicle Temasek.

Asian and global funds combined accounted for about two thirds of the demand, while the rest was split fairly evenly between Europe and the US, one source says. In terms of type of investors, Hong Kong and China corporates û aside from the 12 cornerstones - accounted for about 20% of the order amount, with another 35% coming from high net-worth clients.

Temasek had agreed to buy an additional $500 million worth of shares in the IPO on top of the 4.8% stake it already held in the bank, while the 12 cornerstones, including Ping An Insurance, China Life Insurance, the Bank of Tokyo- Mitsubishi UFJ, Li Ka-shingÆs Hutchison Whampoa and Cheung Kong (Holdings) and Henderson Land DevelopmentÆs Chairman Lee Shau-kee, were guaranteed a combined $2.26 billion worth of shares in return for a 12 month lockup.

Retail investors forked out a total of HK$295 billion to subscribe to the offer, sources said, which is more than on any other Hong Kong IPO - including the first Link REIT offer which was highly popular and attracted retail orders worth $272 billion before it was cancelled for legal reasons.

About 945,000 retail investors were said to have filed an application, which is almost one in every three of the 3 million people in Hong Kong who are typically seen able to subscribe to IPOs (for age or employment reasons). This demand left the 5% retail portion about 76 times covered, which triggered a clawback that boosted the size of the retail tranche to 10%.

In addition, about 9% of the IPO will be allocated to retail investors in Japan through a Public Offering Without Listing.

Observers reckon BOCÆs exposure to high-end retail and corporate clients as well as its greater international exposure made it well positioned to capture the benefits of ChinaÆs continuing economic growth. Investors were also said to have accepted the managementÆs assertions that the bankÆs slower loan growth versus its peers was a result of it being more disciplined and careful in its credit assessment.

The willingness to interpret this as a positive may have been underpinned by news during the roadshow that Agricultural Bank of China had been forced to set aside Rmb35 billion for provisions against bad loans last year, which was almost twice the amount in 2004. The news served as a reminder that despite the rapid economic growth, a lot of borrowers still default on their loans.

Agricultural Bank, the countryÆs third largest lender in terms of assets and the primary source of capital for ChinaÆs rural population, said its bad loan ratio fell marginally to 26.2% last year from 26.7% in 2004.

BOC also had a higher ratio of non-performing loans to total loans than its other peers last year at about 4.6% but the bankÆs total loan growth of 4.1% last year was less than half of CCBÆs 10.4% growth and BoCommÆs hefty 20.5%.

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