Last weeks's A share offering by China's Baoshan Iron and Steel Company (Baosteel) is a record domestic equity offering and one of the most significant deals to come out of China this year. At Rmb7.7 billion ($930 million) the deal is twice as big as last year's Rmb4 billion A share deal for Shanghai Pudong Development Bank, previously the largest Chinese equity deal.
But in all things financial, it is not just size that matters, it is how you do it that counts. And this deal accomplished so much through how it was done, that it will come to be seen as a groundbreaker for years to come. Lead managed by CICC, the deal is the first bookbuild for an IPO in China. The deal was split into three tranches of institutional, strategic and retail shares. 1.427 billion shares were sold to domestic institutional and strategic investors while 450 million shares were sold to retail investors.
The steel comany went out with a price range, built a book with institutional investors and allocated the shares right at the top of the indicaive pricing range at Rmb4.18 per share, in the process achieving a 12 times oversubscription level. In the end 22 investment fund companies, 15 fund management companies and a "whole host of corporate investors" came into the deal, according to sources at underwriter and lead manager CICC. The retail tranche that closed today , Monday, was apparently 5.5 times oversubscribed, showing the demand there is for decent investment product in China.
Distribution of this quality, to such a wide range of investors, showing so much demand for the stock is a huge demonstration of the potential of China's domestic capital marets. Moreover, the price that was paid for the shares equates to a P/E multiple of 18.66 times trailing earnings - a healthy multiple by any standards and one that international investors would probably not have paid. The international offerings of Petrochina and Sinopec are trading at around 6-8 times concensus 2000 earnings. This could have huge implications as Chinese companies decide to go to the domestic equity markets rather than try accessing the international markets.
The effort and cost involved in international capital raising, added to the fact that local investors will pay higher multiples will undoubtedly make the A share market the most attractive venue for mid-size Chinese issuers, at the expense of Hong Kong listings or other international deals.
The flower of reform
This deal was primarily driven by the China Securities Regulatory Commission (CSRC). And it can be seen as the first flower to bloom from all the hard work that has gone into the reform of the Chinese securities industry. For this deal to have flown required a reformed regulatory framework, a revamped investment fund industry and a recapitalised brokerage industry.
It is easy to get carried away by what this deal could mean. There have been many false dawns in China's financial history. But since the institutional tranche closed last Friday November 17, two more of China's best mid-large sized companies have come forward to announce A share plans. China Minsheng bank has announced plans for a Rmb 4.1 billion A share offering while China Everbright Bank has announced plans for its own A share deal.
The difference between these three listings and the previous rash of A share issues in the early 1990s, is in the quality of the companies concerned, the quality of the listing process and the quality of the investor base.
Reports from China say that Baosteel displayed a high level of disclosure in the prospectus and the bookbuilding process, much more than has ever been seen in previous deals. In all departments the quality has improved greatly. This improvement has attracted new money to the market and burnished the overall tone of the domestic market. It is now a serious fund raising option for all the best Chinese companies.
There are challenges that result from this for international banks and investors seeking to participate in this potentially huge A share market. The A share market is shut to foreigners. But with WTO forcing open the gates of the middle kingdom, more participation is expected. The A share markets in Shanghai and Shenzhen are expected to be merged with the B share markets, which are open to foreign participants yet shunned by them.
One of the first challenges is that Baosteel is penciled in to do an international equity deal sometime next year. Indeed it was supposed to go to the markets through lead manager Merrill Lynch this year but that deal was postponed in favour of the domestic deal.
The challenge for Merrill will be to construct the international equity offering according to the parameters that have already been set by the A share deal, and then sell that deal to international investors. While there might not be any direct arbitrage between the A share and the international offering, there will be strong biological links. For instance, the price of the international deal might have to be set off the A share - which is traditionally very highly priced.