China Construction Bank (CCB), the first of China's four state-owned commercial banks to list overseas, raised $8 billion yesterday (October 20) in what marks the world's largest IPO since Kraft Foods in June 2001. The 26.49 billion share transaction (pre shoe) represents a new milestone for the Chinese government as it continues its efforts to overhaul the banking sector.
Having generated $80 billion of demand, the deal stands testament to the pulling power of the country's mega IPO's. Such an outcome is also a far cry from what many would have expected even as recently as early this year.
In many ways CCB's success can be viewed as a natural progression from the achievements of Bank of China Hong Kong and Bank of Communications (BoComm). Both deals have performed well since IPO, enabling CCB to lift the valuation at which Chinese banks can access the international equity markets.
The key test now is how well the deal withstands secondary market trading - whether the huge demand has been driven by momentum, fundamentals or a combination of the two. If investors believe the deal has sound fundamentals, then it should perform well over the coming months and provide a good platform for Bank of China and ICBC to follow.
If, however, investors have viewed it largely as a momentum trade, then some believe CCB may not perform well if markets turn volatile. The leads clearly tried to assuage this by pricing at HK$2.35 - just off the top of the deal's revised indicative range between HK$1.90 and HK$2.40.
At this level CCB has come at 1.96 times 2005 book, 13.9 times 2005 earnings and 11.9 times 2006 earnings. The price to book valuation represents a 22% premium to BoComm's IPO price and IPO trading level of around 1.6 times book, but a 3% discount to BoComm's current trading level, which is around 2.02 times book. Factoring in the need for at least a 10% IPO discount, then CCB has priced at a premium to BoComm.
Morgan Stanley, CICC and CSFB were the joint bookrunners.
Institutional demand amounted to $63 billion, while the Hong Kong public offer drew more than $17 billion of demand and was 42 times oversubscribed. As a result, the retail allocation was moved up to 7.5% from 5%. Had demand outstripped supply by 100 times, the allocation would have increased to 10%.
Some believe that high margin lending rates, the bump up in the price range, and the absence of a local strategic investors dampened retail interest compared to the frenzy, which accompanied the listing of BoComm. Post-offering, the free float will amount to 12%, including the IPO stakes of Bank Of America (BoA) and Temasek.
The former took up $500 million of the offer, while the latter bought in for $1 billion (all new shares). Both investors had already bought old shares in the bank earlier this year, which provided them with a combined 14% stake.
Given its huge size (the largest IPO in four years locally, and the largest IPO ever in Asia ex-Japan), fund managers say it was a deal they could not ignore. CCB is China's third largest bank by assets and the country's biggest mortgage lender. It now becomes the second biggest emerging markets bank by market cap within the Morgan Stanley index.
"By this time next year, the free float of Chinese banks could be as large as that of the banking sector in Hong Kong or Singapore," says one fund manager, explaining one of the reasons he had to buy.
Specialists say demand for the deal built up steadily, with no late momentum-driven surge. About 30% of demand came from institutional investors, 20% from corporates, 20% from the public offer without listing (POWL) in Japan and 30% from the private banking sector.
Demand for the POWL came to $11.3 billion and was led by Daiwa SMBC and Nomura. By geography, final allocations saw 60% placed in Asia, 17% in Europe, 18% in the US and 5% to the POWL.
In total, CCB conducted 120 one-on-one interviews, of which 40 were in the Asia, 30 were in Europe and 50 were in the US. The conversion rate was 74% and specialists say there were 20 orders of over $200 million and a handful of orders for more than that.
Specialists say that BoComm was the natural benchmark for the deal and is currently up 18% since its June IPO. CCB supporters believe the bank deserves to trade at a premium because it has better financials. For example, analysts forecast that CCB will return an estimated 2005 tax adjusted ROE of 19% and an ROA of 0.93% compared to respective multiples of 12.6% and 0.66% for BoComm.
The two Hong Kong-listed Chinese banks command the highest price to book multiples in Asia ex-Japan, with the exception of certain Indian banks such as ICICI and HDFC. ICICI trades at four times book.
Around the rest of Asia, Taiwan's Mega Financial trades at 1.2 times book and an estimated2005 tax-adjusted ROE of 10.8%, while Kookmin Bank has an estimated ROE of 17.7% and trades at 1.7 times book. Of the emerging market banks, only one bank, Brazil's Unibanco trades as high as two times book.
Post IPO, CCB will have a capital adequacy ratio of 13%, the strongest of any listed Chinese bank. Lydia Ling, China banking analyst at Fitch Ratings in Beijing comments, "13% is appropriate rather than high for Chinese banks given the additional level of risk they represent compared to developed market banks, which have minimum CAR's of 8%."
If CCB intends to keep its CAR that high, it could depress the bank's ROE next year, since a high CAR decreases the leverage a bank can exert through the equity multiplier (the inverse of the CAR). But such a strategy would improve the bank's return on assets.
Increasing earnings is one of the key challenges for Chinese banks.
"Although they're gradually being relaxed, interest rates are still quite regulated in many ways, which reduces the scope for increasing interest earnings," says Yan Meizhi, a China banking specialist at Moody's. "While the Chinese banks have moved strongly into consumer lending, an even more attractive area is fee based activities."
Chinese banks only obtain around 11% of their profitability from fee income for activities such as charging fees for credit cards, private banking, commission on selling insurance and surcharges. That compares to around 50% for banks in developed markets.
However, this disadvantage could represent a tremendous growth opportunity, especially for the credit card business. Indeed, it is the growth potential in these areas that some observers argue underpin the Chinese banks' high valuations.
One fund manager who bought into the deal says he has a number of concerns over the short-term and out over the next 12-18 months. "Making money is far more difficult when the deal prices so high. You really need to subscribe to the 'greater fool' theory," he concludes.
Over the longer term, he is concerned the deal is a warrant on the Chinese economy.
"China will continue to crank out great numbers over the next few quarters, but we're cautious on China's macro story" he adds. "Europe looks to be at the peak of the cycle and likely to slow down. If China weakens, CCB is the last stock you'd want to be holding."
According to one specialist, the bank's non-performing loan ratio was a frequent focus of investor attention. "There was some concern that NPLs could spike again if the economy slows," he says.
While many investors bought into the story that the bank's restructuring over the past year is genuine, some believed that the changes are 'cosmetic'.
"If you look at how the NPLs problem was solved, it was through the
stroke of a pen, by transferring them to an asset management company," says one investor.
The presence of Bank of America, which has sent 50 employees to CCB was considered a comfort factor for investors. The issue of who actually controlled the bank, the listco management or the government, was another recurring theme.
The third quarter GDP figures, which have just come out, will be closely watched by investors. GDP was recorded at 9.4% year-on-year, compared to 9.5% at the end of the second half.
"We have some concerns about China's macro environment going into next year. If one relies on the trade data, then about one half of the third quarter's 9.4% growth is due to net exports," says Stephen Green, China Economist at Standard Chartered in Shanghai, adding that the corollary is that all the other drivers of domestic demand (primarily investment) only grew by 4.7% in real terms - a clear sign of a slowdown.
Green notes though, that you get a different story if you look at the data another way, starting with the investment numbers. Fixed asset investment growth was also reported very high in the third quarter, suggesting demand is picking up. However FAI figures are considered to be especially unreliable China. "The more you look into the third quarter numbers, the more contradictions appear", Green says.
CCB will begin trading on October 27.
