Greentown China Holdings and China Grand Forestry know this first hand. The placements for these Chinese issuers, which were completed in the past week, were both done at discounts that were a couple of percentage points wider than what could have been expected under ônormalö market conditions. And while the order flow was still decent, the orders sizes were significantly smaller than before the correction.
With share prices reaching new highs in the secondary market, however, many sellers feel they should be able to get the same type of discounts that were accomplished a couple of months ago. This means the gap between what the sellers want and what the buyers are willing to pay isnÆt getting any smaller.
This was highlighted on Tuesday night when one equity deal got pulled and two others that were widely talked about in the market, never actually happened. The circumstances for each deal was different, but they all seemed to boil down to the fact that the sellers and the investment banks involved û or potentially involved - failed to agree on price.
ôThe core investor base, i.e. the institutions, the mutual funds and the hedge funds, are less active and less willing to take risks and the market is driven more by retail money. This makes the banks more cautious and more anxious about taking on risk,ö notes one banker. ôAnd if the sellers arenÆt willing to give on price, then the bank is unlikely to put the risk on.ö
Hedge funds, in particular, have reduced their activity dramatically either because they think the volatility is too high or because they donÆt have a view on the market for the next three weeks. This means they canÆt be counted on as liquidity providers for these unmarketed deals the way they could six or seven weeks ago, the banker says.
ôFunds arenÆt flooded with cash that they donÆt know what to do with and they are not leveraging themselves these days to levels which we have seen in the past,ö adds another banker. ôThe normal order size from funds these days has probably shrunk by a factor of five to 10. Funds that would normally look for 20, 30 or 40 million are now coming in for 2, 3 or 4 million.ö
Two of the potential deals on Tuesday werenÆt even launched (there is no official record of either of them), but piecing together information from various market participants, it seems one of the trades involved a financial investor who was trying to sell shares of shipping conglomerate China Cosco Holdings worth about $700 million. UBS was believed to have been mandated and was said to have been sounding out the market for an appropriate price range but couldnÆt get the seller to agree to its suggestions. The bank declined to confirm whether or not it was involved.
The other deal, which was to see China Resources Power raise fresh capital from the sale of new shares, didnÆt even get that far. The power generator asked a number of investment banks to submit bids for the follow-on, but never awarded a mandate. According to sources, Citi, Credit Suisse, Morgan Stanley and potentially a couple of other banks submitted bids, however, and the fact that the company didnÆt get back to any of them suggests that it didnÆt like the discounts they were proposing. This deal too was to have been about $700 million.
The third deal was a lot smaller at only about $77 million, but also more interesting because it was already covered and closed when the seller decided to pull out. The deal comprised 20 million secondary shares in paper manufacturer Lee & Man Paper, which were being sold by a group of company directors, including chairman Patrick Lee. The shares were offered to the market at a price between HK$30.20 and HK$31.80, or at a discount of 3.6% to 8.5% versus TuesdayÆs closing price of HK$33.
During the evening, Deutsche Bank, as the sole book runner, informed investors that the book was covered but that there was price sensitivity at the bottom of the range, which led people to assume that the deal would be completed at an 8.5% discount. However, yesterday morning they were suddenly told that the client had decided to withdraw the transaction at the time of pricing.
Sources close to the deal says Deutsche and the seller had agreed on the price range that was then marketed to investors, but when shown the price at the bottom of that range, the seller changed its mind and decided not to go ahead. Such an outcome is highly unusual and some market participants question why company insiders would risk the potential negative fallout from such a move.
Indeed, the brief note sent to investors by the sales team at Deutsche yesterday morning didnÆt explicitly state that the price range agreed with the seller was also the price range at which the deal was marketed. This prompted some speculation that perhaps the bank, in an attempt to bridge the gap between the sellers and the buyers, had used a wider range as a hook to draw investors in and then failed to move them towards the level it had agreed with the sellers.
One market participant noted that there would have been little reason for the seller to agree to an 8.5% discount in the first place given the small size of the deal and the fact that it accounted for less than eight days of trading, based on the average daily volume for the past six months. However, the source close to Deutsche stressed the bank had approached this deal in the same way it would any other deal.
The note from the sales desk said only that Deutsche and the client had prior to the launch ôagreed the terms and conditions including the size of the deal and the price range at which Lee & Man shares be offered. However, the client decided to withdraw the transaction at the time of pricing despite having an oversubscribed transaction within the range marketed.ö
Whatever the background to the cancellation, it seems clear that the seller didnÆt like the 8.5% discount that the investors felt they needed to buy the stock. And most observers see little chance of investors becoming less cautious over the next three weeks, which are likely to be volatile due to numerous economic reports from the US, rate setting meetings both at the Federal Reserve and the European Central Bank, and a bunch of earnings reports from the financial services sector (which could reveal more exposures to US subprime loans).
At the same time, short-covering and retail investors betting on big money inflows when Chinese national are allowed to start investing in Hong Kong stocks continue to drive the Hong Kong market higher, which is likely to add further to the expectations of the sellers.
The two mega deals in China Resources Power and China Cosco will likely return at some point, but may have gotten a little more difficult to do after their respective share prices gained another 1.3% and 3% yesterday. The Hang Seng Index also closed above 24,000 for the first time and is now trading 2.5% above its highs from late July, just before the start of the 3.000-point correction.
ôAs long as people are willing to be realistic about the market environment you can get stuff done,ö one of the bankers says. ôThere is a market out there, but just trying to do a deal at a five percent discount because they were done at five percent six weeks ago is not going to work.ö