China Merchants Securities launched Hong Kong's third largest initial public offering of the year on Monday after opening books for an HK$10.28 billion to HK$11.390 billion ($1.327 billion to $1.47 billion) offering.
On completion, the 891.273 million primary share deal will also rank as the largest brokerage sector flotation of the year, surpassing Everbright Securities, which raised $1.15 billion in mid-August and Orient Securities, which raised $1.005 billion in late June according to Dealogic figures.
But timing is everything and while the parent holds the distinction of being China's first joint stock company (founded the Xing dynasty's star government official Li Hongzhang in 1872), its securities arm is skulking towards the bottom of the pack in terms of obtaining a Hong Kong listing.
Seven of the top 10 brokerages by assets are already listed in the Territory, with third placed Guotai Junan now set to follow China Merchants, after its board approved a listing plan on Monday. That would leave ninth-ranked Guosen as the only brokerage house in the top 10 which does not have a Hong Kong listing.
Launching in the latter half of 2016 has also necessitated a scaling back of China Merchants’ original ambitions. As such, its prospective deal is but one third the size of Huatai and GF's mammoth $4.998 billion and $4.137 billion offerings in 2015, which fortuitously (for them) hit the market at the very peak of China's A-share mania.
However, China Merchants does score better in terms of post-greenshoe IPO size compared to two out of three other close peers, which listed in Hong Kong between 2011 and 2013.
The one it is unlikely to beat (unless it prices towards the top end of its range) is Haitong, which raised $1.85 billion in April 2012.
More importantly, however, it will come at a lower valuation than the 2011 to 2013 troika, which priced at forward price to book multiples varying from 1.24 to 1.31 times.
Based on an indicative price range of HK$11.54 to HK$12.78 per share, China Merchants is being pitched on a syndicate consensus 2016 price to book valuation of 1.1 to 1.2 times and 2016 P/E range of 11.6 to 12.9 times.
These lower valuation multiples are the result of declining efficiency ratios over the past five years (as the industry has become more competitive), the existence of numerous other listed peers and the current poor sentiment towards the Chinese brokerage sector, which turned negative again on September 9.
Until that point, most of China's Hong Kong-listed brokers had largely been on an uptrend since their mid-February lows.
Where China Merchants sits in the pack
In valuation terms, non-syndicate broker Haitong believes China Merchants (eight largest by assets) should sit between Huatai (fourth largest by assets) and China Galaxy Securities (seventh largest by assets, but one behind China Merchants in terms of profitability).
It says its positive stance is based on China Merchant's comprehensive reach and strong investment banking platform.
Huatai is currently trading on a consensus forward price to book multiple of 1.3 times and P/E multiple of 15.55 times Bloomberg consensus 2016 forecast earnings based on Monday's HK$15.88 close (down 12.17% year-to-date).
Galaxy has a lower valuation at 1.1 times forward price to book based on Monday's HK$7.24 close (up 1.97% year-to-date) and forward P/E of 12.27 times.
On this basis, China Merchants is being pitched flat to Galaxy at the bottom end of its indicative range on price to book basis and at an 8.5% discount at the top end.
China Merchants is already listed in Shanghai and its shares closed Monday at Rmb16.82, down 22.49% year-to-date, but up 10.87% on a one-year basis.
This share price equates to a forward P/E of 15 times and 2016 price to book valuation around the 1.86 level, well below its 2.35 times five-year average.
This means the H-share offering will come at a 22% to 14% discount to the group's A-shares pre shoe. This is in line with the current H/A differential of China's largest brokers, which have been converging all year, but will be lower than the discounts Everbright and Orient Securities priced at earlier this year.
Neither of the two recent offerings have performed very well in the secondary market after both pushed IPO pricing off the bottom end of their indicative ranges.
Orient Securities priced at HK$8.15 (just below forward book value) and closed Monday at HK$7.94. China Everbright came slightly above the mid-point of its range and has fared worse.
It priced at HK$12.68 and closed Monday at HK$11.92, down 6.3% from issue. It priced flat to forward book value.
Bankers believe one factor in China Merchants’ favour is the looming Shenzhen-Hong Kong Stock Connect Scheme, which should benefit the broker more than most because Shenzhen is where it was set up in 1991.
Haitong also believes this will help improve China Merchants 2017 overall net profit by 7.8%, although it also believes 2016 earnings will decline by 54% year-on-year because of the unflattering comparison with 2015’s outsized profits.
This was demonstrated by first half earnings, which stood at Rmb2.23 billion ($334 million) compared with Rmb7.33 billion one year earlier. In 2014, the group recorded net profits of Rmb3.88 billion.
Assets continue to grow, however, and this factor has helped to mitigate declining fee commission and efficiency ratios.
Back in 2010, China Merchants was reporting 3.4% for return on assets, 13.9% for return on equity and a net interest margin of 49.8%. At the first half of 2016, these figures stood at 1.9%, 12.2% and 40.6% according to S&P Capital IQ data.
Bankers point out that while trading volumes are well down on 2015 highs, the longer-term trend is for greater direct financing via China’s capital markets and growing uptake of wealth management products, which should benefit all of China’s brokers.
One area where China Merchants has been showing increasing strength is in investment banking although this still only contributed 12.9% of revenues at the end of the first half compared to 73.4% for brokerage and wealth management.
However, the ratio is up strongly from 4.8% one year earlier.
In addition, China Merchants has been one of the chief beneficiaries of the country’s booming domestic bond markets, where it ranks third overall in terms of underwriting market share behind Citic and China Securities and first where ABS issues are concerned.
Pricing of the IPO, which will have a 95%/5% split between the institutional and retail tranche is scheduled for September 30. Listing is expected on October 7.
Relative to its predecessors the deal also has a very large cornerstone component. At the bottom end of the range, 11 cornerstones will account for 62.2% of the deal (pre-greenshoe).
The biggest is PICC Life Insurance, which is buying 333.3 million shares or $523 million at the mid point of the range. The remaining 10 comprise: Chow Tai Fook on $50 million, East Pacific $50 million, China Life group entities $30 million, China Re $30 million, Tencent founder Pony Ma $30 million, Fosun group entities $30 million, State Grid Corp $30 million, Yunnan Metropolitan Construction Investment $30 million, Legit Value $30 million and China South Industries Asset Management $20 million.
Post listing and pre-greenshoe, parent China Merchants group will hold a 44.09% stake. On a pre-shoe basis, the company is offering 13.6% of its issued share capital.
Joint bookrunners are: Deutsche Bank, Mizuho, GF Securities, EBS International, Orient Securities, China Securities, Guotai Junan Securities, Ping An Securities, UBS, ICBC International, ABC International, CCB International, Bocom International and Bank of China International.