Deal activity seen to resume as the Hang Seng hits a new high

Confidence is starting to return as the recovery is supported by expectations of a significant inflow of Chinese household savings.
Six days. That was all it took for the Hong Kong stock market to rid itself from the bearish mood that had pulled it down more than 3,000 points in just over three weeks and return to its pre-subprime crisis levels.

There is no question that there are still concerns about additional fall-outs from the widespread exposure among banks to the US subprime loans, but yesterdayÆs 655-point gain by the Hang Seng Index to a new record close of 23,777 points was a clear indication that this is no longer an issue that will be allowed to have a market-wide impact without a specific reason.

ôThe China individual investment story has taken over as the lead story and some people clearly think this could be a re-rating opportunity for the H-shares,ö says one syndicate banker, referring to the news last week that Chinese individuals will be allowed to invest in Hong Kong equities û albeit initially only through a pilot programme in Tianjin.

Since the announcement of the pilot scheme at around lunch time last Monday, the Hang Seng China Enterprise Index (or H-share index) has rallied 27%, which shows the kind of significance that investors attach to this development. By comparison, the Hang Seng Index is up 16% in the same period. The H-share index tracks state-owned Mainland companies listed in Hong Kong, which are expected to be the first to benefit since Chinese investors are already familiar with them.

The astonishing recovery in the secondary market has prompted renewed activity in the equity capital markets, where bankers are working hard to get the deals at the front of the queue ready to tap into some of this buying frenzy. At least one investment bank was working on a placement for a Hong Kong-listed company yesterday, but in the end it wasnÆt launched û potentially because of the public holiday in the UK that would have reduced the number of available buyers.

The pipeline of initial public offerings that may start marketing over the next couple of weeks is also growing. Companies that have already been through the Hong Kong stock exchange listing hearing are tipped to start at least the pre-marketing process towards the end of this week or early next to coincide with asset managers returning to work after the summer break.

Among those companies, sources say, are Guangzhou-based property developer Aoyuan Corp, which is hoping to raise between $200 million and $300 million with the help of Credit Suisse and Morgan Stanley; China Dong Xiang Group, a sports goods manufacturer which also has the exclusive distributor rights for Kappa sportswear in China and which is looking to raise up to $700 million through an IPO led by Deutsche Bank and Merrill Lynch; and Global Sweeteners, a spin-off from Hong Kong-listed Global Bio-chem Technology which is seeking up to $100 million from a listing arranged by Goldbond Securities.

Queuing for a listing hearing within the next couple of weeks are the likes of China National Heavy Duty Truck, which is expected to raise between $500 million and $600 million with the help of CICC and JPMorgan; Sino-Ocean Real Estate, the property arm of shipping firm Cosco which is targeting as much as $1 billion and has mandated BOCI, Goldman Sachs and Morgan Stanley to handle the listing; and online gaming company Kingsoft, which will be brought to market by Deutsche Bank and Lehman Brothers and hopes to raise around $150 million in the process.

Bankers are also looking at launching a few US IPOs for Chinese companies in the coming weeks, even though the recovery of the US secondary market has been a lot less convincing.

And even in Hong Kong, primary market investors may still need some convincing even if the secondary market is now back where it was a month ago. The August correction has resulted in a pickup in volatility and sharp intraday swings which are clear signs that market players are still worried that another set of bad news could trigger more selling.

ôThe deals will get done, but compared with before the correction there is likely to have been a shift in pricing power which means the terms will have to be more buyer friendly,ö one banker says.

In the short term though, the Hong Kong equity market is likely to continue to be underpinned by the individual investment pilot scheme as part of ChinaÆs huge savings deposits is likely to be diverted to the Hong Kong equity market, according to Credit Suisse analyst Vincent Chan.

Even assuming that just 5% of household deposits leave the Chinese banking system to buy Hong Kong stocks, it would mean an infusion of $112 billion of new liquidity into the market, which is equivalent to 12% of the estimated Hong Kong market freefloat and 19% of the freefloat of Hong Kong-listed Chinese stocks, he says in a research report published yesterday.

The result, according to Chan, will be a re-rating of the H-shares similar to what happened in 2001 when Chinese individuals were allowed to start investing in B-shares. Following that regulatory change, the price/earnings multiple of the B-share market soared to 44 times in June from just 20 times in February.

Given that the current historical price-earning ratio for H-shares is about 24 times, while the A-share market trades at 60 times ôit is difficult to see why Chinese investors would not want to invest in the Hong Kong market to arbitrage the difference,ö Chan says.

However, he does note that this could easily lead to a situation where H-shares get overvalued. He also doesnÆt consider the macro fundamentals (particularly inflation and asset price bubble in China) to be that positive in the long-term.

ôThe net result of this move (allowing Chinese individuals to invest in Hong Kong) is preventing a near-term correction of the H-share market, but it might plant the seed for a much bigger correction afterwards, once the H-share market has been pushed higher,ö he says.
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