Investors shrugged off warnings from numerous commentators and piled into the initial public offering of China Cinda Asset Management – the country’s first distressed debt manager to seek a public listing.
According to sources, the company attracted about $20 billion of demand from retail investors and more than $40 billion of orders from institutional investors, making it one of the most heavily subscribed Hong Kong IPOs in the past few years.
The interest is still well below the $130 billion of demand for AIA’s $20.5 billion IPO in 2010, but is notable since there was a lot of scepticism before the deal as to whether it would even be possible to sell a company sitting on hundreds of billions of dollars of bad debt to international investors.
The demand allowed Cinda to fix the price at the top of the indicated range, at HK$3.58 per share, for a total deal size of HK$19.0 billion ($2.46 billion) and a market capitalisation of $16.4 billion. It also triggered a full clawback that increased the portion of the offering to retail investors to 20% of the deal from 5% initially.
As another $1.1 billion of stock, or 44.4% of the total deal, went to the 10 cornerstone investors, this meant that just under $900 million worth of shares were left to allocate to other institutional investors, presenting the bookrunners with a tough job.
For sure, there would have been a lot of inflation in the overall demand – one Hong Kong tycoon is said to have put in an $800 million order for instance – but sources said the institutional order book included more than 700 accounts, which gives an indication of the breadth of the interest. The quality of the participants is also said to be very high.
All types of investors were represented, according to various sources, including sovereign wealth funds, financial specialists, distressed debt specialists, local, regional and global long only-only funds, hedge funds and high-net-worth individuals. One source said the demand from each one of these investor groups was large enough to cover the entire transaction.
The deal clearly benefited from the fact that it came at a time when there is a renewed appetite for China and as global funds are rotating into Chinese stocks again. As a group, global investors are currently well underweight China and Chinese state-owned enterprises and are looking for ways to increase their exposure, bankers say. A large, liquid stock like Cinda is one way to do that.
Of course, the fact that 10 cornerstone investors, including financial and distressed debt specialists such as Oaktree Capital Group, Och-Ziff and Farallon Capital (previously known as Noonday), as well as Norges Bank, put their names behind it clearly also helped.
Notably, Oaktree has also signed a strategic memorandum of understanding with Cinda alongside its $53 million cornerstone investment, with the intention of helping the Chinese company to maximise the opportunities in China’s distressed asset industry.
Some investors were likely happy to take the cornerstone commitments alone as a sign that this is a worthwhile investment and it is safe to assume that most retail investors didn’t read much of the 814-page prospectus before submitting their orders. But a surprising number of institutional investors did put in a lot of work to try to understand the company and the business model, according to bankers involved in the deal.
The Cinda management helped by meeting a lot of investors around the world before the official marketing period even started and then had three teams participating in the official roadshow to maximise the number of accounts they could see.
After doing the work, investors seem to have come to the conclusion that the valuation was attractive enough – compelling even – to warrant an investment. Or as one banker working on the deal said: “If you believe that China’s property market isn’t going to implode then this is a good bet.” He also noted that Cinda appears to be “exceptionally well positioned” within China when it comes to getting approvals for new products or strategies.
The point about China’s property market is important because Cinda, through the loans that it has acquired since it was set up in 1999 and a recent pickup in its funding support to real estate companies, has a lot of exposure to this sector. The other outsized exposure that has led to warnings about the company’s potential vulnerability in an economic downturn is to the coal sector.
An economic slowdown would in fact have a negative impact on the value of all the assets in Cinda’s existing portfolio, which means the talk of the company being a counter-cyclical play that will benefit from the expected increase in non-performing loans over the next few years, isn’t quite that simple.
Another concern is the uncertainty about the timing and pace of the company’s distressed asset disposal and the sale of the equity that it holds in hundreds of listed and unlisted SOEs as a result of debt-to-equity swaps. At the very least, it suggests that that the company may face a lot of earnings volatility, as noted in one syndicate research report.
However, investors obviously felt that the indicated valuation was attractive enough to compensate for these risks. The final IPO price values Cinda at 1.3 times its projected book value for this year and 1.15 times its 2014 book value, based on the joint bookrunner consensus.
That compares with a median 2014 price-to-book multiple of 2.5 for global alternative asset managers, including KKR, Apollo, Carlyle, Oaktree and Och-Ziff, as quoted in one syndicate research report. However, Chinese banks listed in Hong Kong trade at an average 2014 P/B multiple of just 0.9 times, while the Chinese insurers trade at 1.6 times.
As Cinda is the first of China’s four distressed asset management companies (AMCs) to go public, there are no obvious companies to benchmark it against, though.
The shares were marketed in a range between HK$3.00 and HK$3.58, which put the implied valuation towards the low end of the fair value estimates by syndicate analysts.
Cinda sold 15% of its enlarged share capital in the form of approximately 5.32 billion new H-shares. There is also a 15% greenshoe, which could increase the free-float to $16.9% and the total deal size to about $2.83 billion.
Even without the greenshoe, this is the largest new listing in both Hong Kong and Asia ex-Japan this year, ahead of Sinopec Engineering’s $1.8 billion Hong Kong IPO in May.
The fact that this big a deal can get done this close to year end is a clear sign that China is back in focus. The same trend was seen a couple of weeks ago when Phoenix Healthcare, which owns and operates private-sector hospitals and healthcare clinics in Beijing, attracted more than $5 billion of demand for its $191 million offering. The company received orders from about 300 institutional investors, including European and US accounts.
Hong Kong retail investors, which are good at spotting a “hot” deal, caught on and subscribed to more than 500 times the number of Phoenix shares set aside for them. And they came back in force for Cinda’s significantly larger offering. According to sources, the original 5% retail tranche was about 160 times subscribed, which means it tied up about $20 billion worth of cash.
This is more than the $14.4 billion worth of orders that retail investors put in towards AIA’s significantly larger deal in 2010, and the largest pool of retail money committed to a Hong Kong IPO in the past few years. However, it is well below the $68 billion applied for in China Railway Construction Corp’s IPO in February 2008, which still ranks as the most popular Hong Kong listing ever among retail investors.
One key reason for the optimism is that Cinda offers a unique exposure to a part of China’s financial industry that has so far been out of reach for stock market investors and that is viewed to have strong growth prospects as non-performing bank loans (NPLs) and distressed receivables are expected to increase in the next couple of years, following five years of massive credit injections into the Chinese corporate sector.
Cinda and China’s other three distressed AMCs were set up in 1999 to acquire and manage a huge amount of NPLs from the country’s largest state-owned banks as they prepared for a stock market listing. Since then, their role has widened quite significantly to include the acquisition and restructuring of distressed debt from state-owned enterprises outside the banking sector and they are now also allowed to buy loans at a discount to face value – typically at 25 to 30 cents to the dollar and sometimes as low as 10 cents – which makes it a lot easier to achieve a profit.
Cinda has also moved into other financial services, such as brokerage, investment banking, principal investments, trust services, financial leasing and insurance and in 2012 it raised new capital through the sale of equity to four strategic investors, including UBS and Standard Chartered Bank.
As of the end of June, Cinda had $284 billion of total assets, which makes it the largest among the four AMCs and, according analysts, puts it on par with China’s large-sized city commercial banks. About 56% of the total asset value comes from distressed assets and the management of such assets contributed just over 70% of the Rmb5.1 billion pre-tax profit in the first half of this year, according to a syndicate research report.
Several research reports note that Cinda has achieved an internal rate of return of 18% to 20% on its NPL portfolio, excluding the initial loans that were bought at face value, while the restructuring of distressed debts from non-financial sector enterprises is generating yields of 12% to 13%, resulting in a return-on-assets of more than 4%.
Bank of America Merrill Lynch, Credit Suisse, Goldman Sachs, Morgan Stanley are joint sponsors as well as joint global coordinators together with BOC International, CCB International and UBS.
Cinda also appointed another 11 banks as joint bookrunners, namely ABC International, Bocom International, CICC, Cinda International Securities, Citic Securities, CMB International, China Merchants Securities, Essence International, ICBC International, Jefferies and Standard Chartered.
Cinda will start trading on Hong Kong’s main board on December 12.