A decline in Hong Kong stocks on Friday reminded market participants that a potential recovery from the slump in share prices will not happen in a straight line and clearly shows that the market remains very headline-driven.
On Friday it was Standard & Poor’s downgrade of Spain’s credit rating to AA-, or the same level as China, and the fact that China seems unable to bring down its inflation rate that rattled the markets. China’s CPI inflation data was in line with expectations, but many investors used both of these issues as an excuse to take profits after the Hang Seng Index had gained 15.4% during the previous six sessions. The eagerness to do so shows that, despite the recent rally, there is a lack of conviction in the market and suggests that bankers will still have a hard time pushing out deals in the equity capital markets.
Given the lead time for IPOs, that part of the market is going to remain challenging until it either stabilises or is able to demonstrate a sustainable recovery. As it is now, daily volatility makes it very difficult to set price ranges for IPOs.
However, until Friday, the recovery had made bankers more optimistic about a pick-up in block trades as a way to kick-start the market. In Hong Kong, such deals can be done without prior filing and since they are typically launched after the market closes and completed the same night, there is much less price risk for the buyers.
Indeed, some bankers say potential buyers have started to ask for opportunities to buy shares at a discount through block trades as they increase their exposure again. And, as a result, banks are once again knocking on doors at institutions and companies trying to match such buying interest with willing sellers.
A key hurdle for blocks, though, is that many potential vendors do not want to sell at current share prices. This is particularly true for corporate issuers, which are not keen to issue new shares if they feel their stock is undervalued. But, not all shares have been hit as badly in the past couple of months. There are stocks that are still trading close to their 52-week highs and there are also investors who are sitting on gains that they may want to monetise, especially if they still have a negative view on the market. According to bankers, the most likely sellers are found in the latter category and include both institutional investors and private equity funds.
Another difficulty is that even cheap valuations may not be enough to attract buyers as many investors are focusing more on technical issues these days than on fundamentals. The most important gauge is the relative strength index, which indicates whether a stock is over-sold, or indeed over-bought.
The dialogue between bankers and potential sellers has gained pace after the turnaround in the Hang Seng Index from a low of 16,250 on October 4, but so far no trades have materialised.
Sell-down by AIG in AIA
One possible trade that is attracting a lot of attention is a potential sell-down by AIG of its remaining stake in pan-Asian insurer AIA. AIG still owns 32.9% following the listing of AIA in Hong Kong last year and will be able to sell half of that after a 12-month lock-up expires on October 29. As of the close of trading on Friday, the stake was valued at about $12.2 billion.
Hong Kong-based bankers are divided over whether US-listed AIG will sell right now, but speculation that there will be some form of divestment increased last week after a fund manager at Pimco told Bloomberg TV that the fund was “selectively accumulating positions in China”. And while not specifically saying that Pimco was eyeing AIA, she added that its shares are poised for “a lot of capital appreciation”.
Needless to say, banks have been busy calling on both AIG and Pimco since that interview.
If AIG does decide to sell, there are plenty of possibilities for how a sale might be structured. While the lock-up expiry at the end of the month relates to only 50% of its shares, the remaining shares are locked until April 18 next year with the IPO underwriters only and can be waived if the underwriters believe there is reason to do so. The lock-up under the Hong Kong listing rules expires in full on October 29.
In addition to a potential waiver, AIG’s agreement with the IPO underwriters allows it to sell its entire stake if it is sold either to one strategic buyer or through a privately negotiated transaction with a small number of buyers, similar to the Bank of America Merrill Lynch divestment of China Construction Bank shares in August. The condition is that that the buyers will adhere to the remaining lock-up.
To find one buyer that can put up more than $10 billion to buy AIG’s entire stake in the current market environment is not very likely and if one buyer was to buy more than 30% of AIA it would also trigger a mandatory general offer to minority shareholders, which is probably not an outcome that AIG wants. One way to get around this would be to sell the bulk of the shares to a strategic buyer and then do a clean-up trade with the rest of the shares in the capital markets — investors have responded positively to similar block trades during the past few months. However, it is unclear if a buyer would want to put up that much money without getting a controlling stake.
Even if AIG sticks to the lock-up and chooses to sell only half of its shares, it would be a chunky trade at close to $6 billion. Hence, a privately negotiated transaction seems more plausible, or perhaps a combination of a private deal and a smaller block trade in the public market.
Among the incentives for AIG to sell is the fact that the company still needs money to pay down the remainder of the bail-out capital it got from the US government in 2008. And while AIA’s share price has fallen 19.1% from its high of HK$29.55 at the beginning of early August, it is still trading 21.4% above its IPO price of HK$19.68. That last argument has gotten stronger during the past week-and-a-half as the stock has rebounded from a 12-month closing low of HK$19.94. Even before that, AIA was the best performing insurance stock in Asia and one of the best performing shares in Hong Kong during the past 12 months.
To be sure, there are those who reckon AIG is in no hurry to sell, arguing on the one hand that its need for capital is a lot less urgent than it was at the time of the IPO and on the other that AIG would want to hold on to its AIA shares to make the most of its strong performance.
On Friday, AIA reported a 53% year-on-year increase in the value of new business to $245 million for the three months ending August 31 — a quarterly record for the firm. Annualised new premiums (which comprise 100% of annualised first-year premiums, plus 10% of single premiums, and exclude corporate pensions) rose 52% to $766 million. Total weighted premium income improved by 14% to $3.75 billion. The latter comprises 100% of renewal premiums, 100% of first year premiums and 10% of single premiums.
In a release, the company noted that the drivers of future growth in the Asian insurance markets remain firmly in place: “Rising affluence is profoundly important in extending the scope for long-term savings and, with accelerating healthcare costs further increasing demand for medical protection across the region, consumers are seeking greater security and stability which will also benefit AIA."
AIA is likely to remain in focus as the lock-up expiry draws closer, or at least until AIG clarifies what it plans to do. Such speculation could start to act as a bit of an overhang on the share price. However, in a research note issued Friday, Deutsche Bank analysts Esther Chwel and Tracy Yu argued that any weakness resulting from this should be viewed as a “buying opportunity for a great franchise with strong capital position”.
According to AIA’s listing prospectus, AIG’s commitment under the Hong Kong listing rules meant it could sell shares in AIA six months after the listing, providing that it still owned at least 30% (which constitutes a controlling stake in Hong Kong). However, its parallel agreement with the IPO underwriters was stricter and didn’t allow AIG to sell any shares during the first 12 months after the publication of the prospectus on October 18, 2010, and even after that the parent can, as earlier mentioned, sell only 50% of its shares until 18 months after the date of the prospectus.
In practice this means that AIG will be free to reduce its stake from 32.9% to 30% after tomorrow, but that is unlikely to make much difference to its divestment strategy. The date everyone is watching is October 30 when half of its shares can go on the block. For now though, AIG is keeping its divestment strategy close to its chest.
