Investment bankers in Asia were busy in December celebrating distressed asset management firm Cinda's $2.4 billion initial public offering, the biggest IPO out of China for about a year. However, those bankers are now still waiting for their pay cheque.
The company told arranging banks that they would only know the fees they would be paid up to three months after deal closure and would have to wait up to six months to receive payment. These fees would also be divvied among 18 bookrunners.
Cinda reflects the dynamics at play in China for 2014 that could have a bearing on how Asian investment banking fares as a whole. On the one hand, dealmakers are optimistic that the year of the horse will usher increased deal flow from China as the country emerges from a painful hiatus. But extracting fees from its state-owned companies can be frustrating.
From a fee perspective, China is key. China’s share of Asia ex-Japan’s investment banking revenues rose to 51% in 2013 from 36.5% in 2006, data from Dealogic shows.
“China is a key driver for Asia’s investment banking revenues,” said Matthew Hanning, head of investment banking Asia Pacific at UBS. “It drives everything from Australia’s mining sector to the region's IPO markets," he said.
There are good reasons for optimism in 2014. The long-awaited changes within Communist China's top echelons are now done and dusted and much of the political uncertainty that has kept Chinese executives from undertaking major decisions has been removed. Investor appetite is also returning.
“There is a lot of positive momentum. The China IPOs are recovering and there has been more M&A, and debt markets continue to grow,” said Matthew Ginsburg, head of investment banking Asia Pacific at Barclays.
To be sure there are risks to the downside, from the long anticipated Federal Reserve's tapering of US policy stimulus to the riots in Thailand and upcoming elections in India and Indonesia. Investment banks are also cautious about betting big on a potential rebound in Chinese deal making having only just emerged from painful cost-cutting exercises.
Investment banking revenues in the region have fallen since 2010, chalking up to $5.9 billion in 2013, which is 37% lower than in 2010. Fees have fallen due to a relative drought in China IPOs and those fees are now being spread among more banks, with increased competition. “The feeling on the street is that Asia is over-banked and for that reason, I don’t see aggressive hiring in 2014,” said Dieter Turowski, co-head of Asia Pacific investment banking at Morgan Stanley.
CHINA RED FLAG, BOOKRUNNER BLUES
Many US investors sat out of China IPOs in the first half of 2013 due to the corporate governance issues that Chinese companies face, leaving them to be taken up by non-institutional investors. However, with China IPOs trading well in the secondary market in the fourth quarter there was a change in sentiment. “The China equity business is coming back. Investors are more open to China IPOs," said Barclays’ Ginsburg.
There is a pipeline of jumbo IPOs that are expected to launch this year, including Hong Kong Electric Investment’s IPO to raise up to $5.7 billion, meat processing giant Shuanghui International, drugstore group Watsons and China Guangfa Bank.
“My own read on 2014 is that it will be stronger driven by China and Hong Kong and I am reasonably confident that we will see a higher volume of IPOs,” said Ashok Pandit, head of ECM Asia at Deutsche Bank. "The number of transactions that have come out of China in the last six to eight weeks has been very strong and the pipeline is very large," he added.
Many of China’s mega state-owned IPOs, once the gravy train for investment banks, have already been completed, but the private sector offers promise. “The upcoming China state-owned IPOs will be smaller than what we have seen in the past,” said Morgan Stanley’s Turowski. “On the fees side, I expect our China business to be underpinned by the private sector,” he said.
Competition is ferocious and based on the swelling number of bookrunners on China IPOs (17 on Chinese insurer PICC’s IPO in November 2012), banks have been scrambling for any piece of the business they can get. But at the same time, shareholders demand a higher return on equity and discipline.
Increasingly, banks are focused on overall wallet share and on playing a leading role, where they can get a bigger share of the fees. “On the large China IPOs we are focused on transactions where we can play a global coordinator role," said Farhan Faruqui, regional head, Asia Pacific corporate and investment banking at Citi. "If you are not on the top line you are not playing a driving role and that is where you can add value for the client,” he said.
GREAT WALLOF CHINA DEBT
China offshore bond issuance, which blossomed in 2013, is expected to continue to grow, driven by GDP growth and a thirst for offshore capital. China state-owned bond issuance grew fourfold from 4.8% of the offshore bond market in 2010 to 22% in 2013. China’s debt markets are expected to continue to deepen in 2014 as companies seek to diversify their funding.
“China is seeing real growth and very soon we will look at the Asian dollar market as being dominated by China issuance, with the other countries playing a supporting role," said Stephen Williams, head of capital financing for Asia Pacific at HSBC. "The large oil companies have become regular issuers in dollars and euros while the smaller [state-owned enteprises] that have yet to tap the market are seeing the rates and sizes that [are] available," he added.
China-based issuers already dominate the index and represent the single-biggest country concentration in the benchmark JP Morgan Asia Credit Index, accounting for about 25% of the index weighting.
Debt bankers are also positioning themselves in 2014 for a wave of Asian Basel III bank capital issuance as banks replace old tier-2 bonds with new Basel III bonds.
Asia’s national regulators are idiosyncratic and the structure of these new instruments will vary from country to country. Banks are leaning towards write-down structures, where investors can lose the entire principal upon certain trigger events, rather than structures that allow the bonds to be converted to equity, according to debt bankers.
The wave of conversion already started last year in Singapore, where UOB and DBS began replacing their old tier-2 bonds with new Basel III bonds. China’s Citic Bank and ICBC Asia also sold US dollar-denominated Basel III bonds in 2013. Given the complexity of Basel III bonds, asome Asian regulators are wary of allowing them to be sold to domestic investors, which could force banks to tap the dollar market.
“2014 is going to be key when it comes to bank capital and we could see some jumbo mandates out of China and a fair bit of issuance from Asean [countries] and India,” said Amit Sheopuri, co-head of debt origination at Citi.
However, 2014 is also poised to be a tricky year with interest rates expected to move up. Rising interest rates would signal improving economic growth but could cause market disruption too. “How quickly rates drift higher could make or break the year for investment-grade bonds,” said Herman van den Wall Bake, the Asia head of debt capital markets at Deutsche Bank. "High-yield bonds trade at a wider spread over Treasuries and can absorb movement in rates without as much pain.”
M&A: THE DARK HORSE
Mergers and acquisitions (M&A), the third leg of investment banking, continued to punch below its weight in 2013 as China focused on cleaning its companies up. Top executives at Chinese state-owned enterprises (SOEs) were reluctant to undertake bold acquisitions because they were unsure if they would hold the same position in the coming months.
However, with the periodical reshuffling of China’s ranks now over, M&A could be the dark horse of 2014 and surprise on the upside. “The sense that the commodity cycle has bottomed out and China's leadership changes have taken place ought to lead to a pick-up in M&A activity in 2014,” said Joseph Gallagher, head of M&A, Asia Pacific at Credit Suisse.
Early signs suggest that pick up is already underway, with China Construction Bank buying Brazil’s Banco Industrial e Comercial (BicBanco) and Chinese trading firm Yue Xiu making an offer for Hong Kong’s Chong Hing Bank.
Bankers expect slowing economic growth in China will force unprofitable companies from steelmakers to mining companies to consolidate more, driving domestic M&A. “We expect to see more consolidation as a slowdown in growth exposes unsustainable cost structures,” said Richard Campbell-Breeden, head of M&A Asia Pacific ex Japan at Goldman Sachs.
Domestic M&A, which historically has not paid particularly well, offers more opportunities for banks now as deals become more complex. “When I first moved out to the region, international investment banks did not get involved very much with in-market Asian M&A,” said Ginsburg. “That has definitively changed,” he added.
However, given the growth in Asia, the region's M&A activity lags behind the US or Australia. One of the reasons cited is that a high-level of ownership lies in the hands of rich families or the government, which may not be interested in seeing the asset changing hands. "In Australia, 90% of the time a bid is made, there is a change of control," said Hanning. "But in Asia, M&A is often seen as a discussion with a major shareholder," he said.
Western companies that are keen to buy into Asia’s consumption story also find it difficult to get hold of assets at a decent price. “It’s getting harder to buy assets in Asia,” said Campbell-Breeden.
