ECM Most Wanted: reward for follow-on deals

Why has issuance not been stronger given secondary market performance?

Secondary market equity issuance has failed to pick up as expected so far this year, but bankers remain confident companies will start to take advantage of benign market conditions at a time when emerging market inflows remain strong.

“Follow-on market activity has been disappointing,” said Alex Abagian, head of Asia Pacific equity syndicate at Morgan Stanley in Hong Kong. “Once the H-share index breached the 10,000 level we expected issuance to start accelerating, but it hasn’t happened yet.”

As FinanceAsia reported in part one of its autumn ECM preview, overall issuance across Asia (ex A-shares) is on course to surpass 2016’s $77.4 billion total given issuance of $57.5 billion in the eight months to August and a strong IPO pipeline over the final four months of the year.

However, it does not look like the region will be able to hit 2015’s $140.5 billion volume, largely because there has been less follow-on issuance out of the region’s dominant market, Hong Kong (see table one, although these figures include A-share companies seeking H-share listings).

Instead, it has been India, which has been largely adding bulk to the league tables for the first time in the region’s history (to be discussed in part three).

Bankers believe the main reason is because equity market rallies have come from a low base.

For example, the Hang Seng China Enterprises Index (HSCEI) closed Friday at 11, 149. It has put in a strong performance both year-to-date (up 18.68%) and since its February 2016 lows (up 48.1%).

However, the index is still 23% below its 14,536 peak in April 2015. More importantly, the HSCEI’s current valuation around 8.12 times forward earnings is below its 11.8 times long-term average (15 years).

Likewise, the Hang Seng Index closed Friday at 27,668, up 25.76% year-to-date. It is currently trading around 12.2 times forward earnings, slightly below its 12.5 times long-term average.

“The buy side has been very open to new deals, but companies have been waiting for the next leg-up before they consider issuing additional equity,” said Akram Zaman, head of Asia Pacific equity syndicate at Bank of America Merrill Lynch. “Furthermore, alternative financing sources such as the loan and bond markets have also kept corporates on the sidelines from an equity standpoint.”

Both Abagian and Zaman expect this to change provided markets continue to remain favourable.

Sustainability of EPS upgrades

“Market conditions are similar if not better than they were during the second quarter of 2015,” Abagian stated. “At that point, the strong A-share rally was dragging the Hong Kong market up with it, but long-only funds were still negative on China and structurally underweight. It was mostly hedge funds driving international flows. 

"This rally feels a lot more sustainable and progressive, underpinned by what appears to be a sustainable bid by global mutual funds and more consistent southbound flows” he continued. “The majority of deals coming to market have also shown a solid aftermarket performance and we have seen single long only investors anchoring deals in size, taking up to one third of paper as a way to quickly gain single stock exposure."

First half earnings across Hong Kong and China have also been strong, beating consensus estimates by about 7% to 8%.  In a recent research report, UBS noted that A- and H-share revenue and net profit figures across MSCI China Index constituents were up 15% and 17% respectively year-on-year, or 19% and 42% excluding financials.

Key will be whether investors believe this momentum can continue.

Financial analysts paint a mixed picture. UBS, for example, believes MSCI China Index earnings for non-financial stocks have peaked and will likely “decelerate on weaker demand, lower margins and an unfavourable base effect.”

However, the investment bank believes banking and insurance stocks will do well thanks to rising net interest margins, lower asset quality concerns and faster premium growth.

Asia (ex-Japan) ECM IPO and FO Deal Volume January to August
  2015     2016     2017    
Type Value ($m) No. % Value ($m) No. % Value ($m) No. %
Follow-On 142,196 827 77.50 116,102 722 82.04 89,516 652 67.56
IPO 41,278 386 22.50 25,408 333 17.96 42,986 610 32.44
Total 183,474 1,213 100.00 141,511 1,055 100.00 132,502 1,262 100.00
SOURCE: Dealogic

Market risks

Yet what should be of more concern to Asia is what is happening in Europe and particularly the US. The S&P 500 Index, for instance, is close to one standard deviation above its 30-year mean on trailing earnings basis and concerns about a potential correction are rising.

One banker said this nervousness is translating into sharp corrections for individual stocks in developed markets, which miss earnings.

Zaman also noted that “broader macro concerns and geopolitical risks have forced investors to park capital in larger liquid names, which have solid, inherent fundamentals".

He said investors believe they will be better insulated from external factors and downside risk if they opt for larger companies, which can consistently deliver on results.

“Institutional investors are flocking to higher quality names with strong liquidity profiles and are consequently willing to pay higher valuations for these assets,” he added.

Zaman also pointed out that “passive and index funds have been adding to existing positions and active managers maintaining more concentrated positions within portfolios. This has resulted in rising stock prices, especially for mid and large cap names and improved fund performance year-to-date.”

The four biggest downside risks being flagged across global markets are: changes to central bank balance sheets; German elections; rising tensions across the Korean peninsular and peaking Chinese growth.

Abagian believes that if these risks escalate and volatility spikes, it may actually lead to more equity issuance rather than less. “At that point, companies may feel their stock has had a good rally and it makes sense to seek equity finance sooner rather than later,” he concluded.

If they do proceed, they will be entering a market where liquidity has picked up (Shenzhen-Hong Kong Connect has helped push average daily turnover up 20% in Hong Kong year-to-date). Funds are also long inflows ($8 billion net into Asian emerging market funds so far this year) and are mostly still underweight across some of Asia’s biggest markets, most notably China.

As Abagian noted: “China’s structural underweight position has been reduced, but notwithstanding the strong secondary market rally, our view is that funds are still not even neutral yet. This gives us a lot of confidence with regards to the market continuing to be on an uptrend over the coming months."

China’s domestic stock markets are also still playing catch-up with Hong, having only begun to rally in early May. Year to date, the Shanghai Composite Index is up 8.43%, 10 percentage points below the HSCEI. 

Equity strategists describe this as one of the most positive factors potentially driving the Hong Kong market across the fourth quarter, balanced against fears the US market could turn.

Morgan Stanley suggests the market may see a better flow of traditional block deals from equity owners wanting to monetize a 10% to 15% stake without losing overall control.

Tucker Highfield, head of Asia Pacific equity syndicate at Credit Suisse agrees. He added, “ I think we’ll start to see more issuance from the property and financial sectors. The former has been reporting good earnings, while some of the latter’s stock prices are trading at multi-year highs.”

 “We’re confident about the ECM outlook,” Zaman concluded too. “A number of best-in-class corporates are likely to hit the equity markets in the region. Strong secondary performance, positive fund flows into equities and a returning bid for emerging markets should help regional activity to increase further.”

Asia (ex-Japan) ECM IPO and FO Deal Volume - ex-A Shares January to August
  2015     2016     2017    
Type Value ($m) No. % Value ($m) No. % Value ($m) No. %
Follow-On 84,567 657 83.09 24,533 435 63.18 35,793 471 62.23
IPO 17,207 194 16.91 14,299 218 36.82 21,726 309 37.77
Total 101,774 851 100.00 38,832 653 100.00 57,519 780 100.00
SOURCE: Dealogic


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