BoComm blowout

IPO of Bank of Communications surprises everyone on the upside.

China's Bank of Communications (BoComm) is set to become the first Chinese bank to list overseas after a remarkable response to its IPO that has confounded almost everybody. The Mainland's fifth largest bank by assets raised HK$14.65 billion ($1.88 billion) this Saturday (June 18) after pricing its H-share IPO at HK$2.50 per share.

Under the lead of joint bookrunners Goldman Sachs and HSBC, the bank was able to price a 5.856 billion share deal (pre shoe) a fraction off the very top of a HK$1.95 to HK$2.55 indicative range.

At $54 billion, the order book is the second largest on record for a Hong Kong Stock Exchange listing. Only China Life's IPO of December 2003 ranks higher at $80 billion, although Link Reit would have come second had it not been de-railed by an elderly petitioner late last year. As such, the sheer scale of demand has provided an unexpected vote of confidence in the Chinese financial sector, or at the very least signals that momentum is returning to the Hong Kong and China IPO market.

The retail tranche is said to have attracted demand of just over $19 billion, representing an oversubscription ratio of 205 times based on an initial offer size of 293 million shares.

The placement tranche attracted demand of $34.5 billion, equating to an oversubscription ratio of 27 times post-clawback, post HSBC top-up and pre-greenshoe. Of this amount, high net worth investors applied for $10.5 billion, institutions $10.2 billion, corporates $7.95 billion and Japanese retail $5.9 billion.

Allocations were affected by a top-up from HSBC, which purchased 19.97% of the IPO in order to maintain its stake in the bank at the same level. So too, clawbacks were triggered, which pushed retail up from a 5% to 20% allocation.

The remaining 60% was split 56% institutions, 28% corporates, 13% high net worth investors and 3% Japanese POWL (Public Offering Without Listing) run by Daiwa SMCB. This means that institutions have been allocated 34% of the overall deal, corporates 16.8%, high net worth investors 7.8% and the POWL 1.8%.

About 340 institutional investors placed orders, of which four came in for more than $200 million and 20 for more than $100 million. The bulk are said to have fallen in the $20 million to $40 million range.

There was similarly heavy demand from corporate investors, with 200 orders registered and 110 allocated. The top 15 corporates placed orders ranging from $100 million to $400 million.

By geography, Asian investors accounted for 82% of demand, European for 12% and American 6%. By allocation, Asia got 65%, Europe 23% and the US 12%.

In many respects BoComm has proved to be a mirror image of its predecessor Bank of China Hong Kong, which completed a $2.47 billion IPO (pre shoe) in July 2002. Like BoComm, the Hong Kong-based arm of China's largest banking group similarly surprised the entire market by being able to price near the top of its indicative range after attracting an order book of $19 billion.

In both cases, retail and corporate demand came in early and in size. Institutional investors, on the other hand, sat on the sidelines until the very end of the marketing process.

Specialists say institutional demand only really began to pick up steam during the last three day's of BoComm's bookbuild, when accounts could clearly see the deal had very strong momentum. Up until this point, they say it had taken a considerable amount of "investor education" to get many to budge off their initial valuation estimates around the level of 1.1 to 1.3 times 2005 book.

In the end, the deal was priced at 1.76 times 2005 book on a pre-money basis and 1.58 times on a post money basis. At the time of its IPO, Bank of China HK priced at a premium to the Hong Kong sector at 1.65 times forward book.

It is currently trading at just over two times in line with the Hong Kong average, but above the regional banking average of 1.8 times.

In 2002, Bank of China is said to have attracted a huge retail and corporate following because of the strong brand name it had been able to build up thanks to its 80-years operating history in the Territory. In 2005, HSBC is said to have had the same effect for BoComm.

The bank currently owns 19.97% of BoComm, but has an option to double its stake pending regulatory approval, effectively taking control. Retail investors would therefore appear to have bought into the story that HSBC can perform the same miracles in China it has done with its own asset base and earnings over the years.

Specialists say it is hard to overestimate the incredible hold HSBC has over the psychology of Hong Kong investors. It is the Territory's de-facto brand-name and a core portfolio investment that has consistently well rewarded those who own it.

Likewise, Bank of China Hong Kong has delivered strong investor returns since its IPO. Together these two factors may have given retail investors confidence to take the next step into the Chinese banking sector - pure exposure to a Mainland financial entity rather than indirectly through a Hong Kong proxy.

Having priced at HK$8.50 per share, Bank of China has risen 65% over the past three years to a current share price of HK$14. It has been able to do so by delivering better quality earnings through improved ROE and ROA.

The former has risen from 6.47% in 2001 to 18.6% in 2004, while the latter has jumped from 0.34% in 2001 to 1.53% over the same period.

BoComm is now spinning the same message. During roadshows, chairman Jiang Chaoliang told investors the bank's chief objective will be to maintain sustainable ROE in the mid teens.

During 2004, BoComm recorded an ROE of 4.5%. In 2005, the figure is expected to jump to 15% - after fully accounting for HSBC's capital injection in 2004 and IPO proceeds generated in 2005.

Consumer finance will also become a much strong focus that should improve ROA from just 0.17% prior to its restructuring. Within a year, HSBC and BoComm will launch a credit-card joint venture that HSBC is expected to have majority control of.

"Generating fee income business is the way forward and maximising interest spread is just what HSBC is good at," comments one China specialist.

Specialists say institutional investors were impressed by the roadshow performance of BoComm's young management team. They were also on a very steep learning curve.

"It was really very surprising to discover just how little global investors knew about the Chinese banking sector," says one participant. "There's been plenty of research out there in recent years, but no-one appears to have read any of it. Perhaps they felt that past research relied too heavily on government statistics, which just weren't trustworthy enough."

As a result, most accounts started out with a highly sceptical view and very low valuation expectations. These were finally lifted towards the end of roadshows and specialists say there ended up being very little price sensitivity in the final order book.

They believe this will have a positive and negative impact on the big four state-owned banks that hope to follow BoComm's lead. On a positive footing, BoComm has generated a great deal of momentum and created a near perfect template for its domestic counterparts.

On a negative footing, international investors may now feel knowledgeable enough to make qualitative distinctions between Chinese banks in a way they have not done for other sectors. For example, where the Nasdaq-listed China tech stocks are concerned, investors often seem to bracket them all together. This has particularly been the case with the SMS-related companies.

This attitude may not bode well for the big four, given the much larger size and nature of the problems they face. A number of equity capital market bankers consequently believe it will be difficult for them to maintain their current tentative listing schedules and overcome ingrained investor wariness.

This may further underpin BoComm's valuation because the bank will have scarcity value for longer and be able to maintain a higher premium relative to its peers.

Having priced at 1.58 times forward book, BoComm has left a lot slack for others to follow. Achieving a good premium to book value was very important since BoComm will set the high water mark for valuations and the Chinese government does not allow state-owned assets to be listed below book value.

But it remains to be seen whether investors will pay more than one times book for something like China Construction Bank (CCB) when there are much stronger banks in Asia such as Korea's Woori Financial Holdings trading below book value.

Whether they are prepared to make this leap of faith will in part depend on their view of Bank of America's strategic stake. Last Friday, the American bank announced that it will pay $3 billion for a 9% stake in CCB.

However, as detractors are already pointing out, Bank of America does not enjoy the same goodwill among Hong Kong retail investors as HSBC does and nor does it have the latter's operational expertise in either Asia or China.

How retail investors behave over the next few days may also determine how well BoComm trades in the secondary market. Many may have purchased the stock in a belief it would price cheaply because market conditions have been so bad.

High pricing may therefore encourage a lot of investors to flip the stock straight out. This will, however, be tempered by the fact that retail has only been allocated 20% compared to the customary 50% for such a highly oversubscribed IPO.

Management at Minsheng Bank may also now be ruing their decision to postpone the bank's Hong Kong IPO for fear of achieving too low a valuation. Analysts say that instead of piggy backing off BoComm's success with an overseas listing, the bank is now examining other ways to boost its capital over the next few months.

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