Galaxy Securities starts investor education for IPO

The company is aiming to raise up to $1.5 billion to become the second largest Hong Kong listing this year after Sinopec Engineering, which is also pre-marketing at the moment.
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Galaxy Securities: China's biggest brokerage network
<div style="text-align: left;"> Galaxy Securities: China's biggest brokerage network </div>

Contrary to information provided by some bankers involved in the deal last week, investor education for China Galaxy Securities’ initial public offering in Hong Kong will start today.

Sources said during the weekend that all the necessary approvals are in place and, while the exact terms have yet to be determined, the company and its bankers are now ready to seek formal feedback from investors.

Galaxy Securities is China’s leading brokerage firm in terms of client deposits and the number of outlets, but is well behind its two Hong Kong-listed peers when it comes to equity and bond underwriting, proprietary trading and asset management. It is seeking to raise between $1 billion and $1.5 billion from the IPO, according to sources.

Cornerstone investors are expected to take up a significant portion of the deal, but the exact size of their commitment is still under negotiation. And since the company has indicated that the role of the banks involved in the deal will be directly related to how much cornerstone demand they bring in, the final line-up will also not be firmed up until closer to the launch of the management roadshow and bookbuilding.

For now, the deal is being led Goldman Sachs, J.P. Morgan and Galaxy’s own international investment banking arm, Galaxy International, which are the IPO sponsors. The company has also mandated 13 other banks to help bring it to market. However, it hasn’t appointed any global coordinators or bookrunners yet.

During the weekend it emerged that not all of the banks will print research and get involved in the investor education — a job that is usually shared by all the bookrunners on an IPO. As a result, it is possible that some of the 16 mandated banks will end up getting a more junior role in the syndicate.

In addition to the sponsors, the banks working on the deal right now are ABC International, Bocom International, Bank of America Merrill Lynch, Credit Suisse, CCB International, Citi, Deutsche Bank, Haitong Securities International, HSBC, ICBC International, Nomura, Standard Chartered and UBS.

The current plan is to sell 20% of the enlarged share capital in the form of 1.5 billion new H-shares, plus a 15% greenshoe. However, one source said it is possible that the deal may be increased slightly depending on the feedback during the investor education. It is also not clear whether the National Social Security Fund will sell some or all of the H-shares that it is set to receive as part of the offering. As per Chinese regulations, the NSSF receives shares equivalent to 10% of all primary H-share issuance by Chinese companies. Sometimes it sells those shares as part of the IPO, sometimes it holds on to them.

The deal will have the usual split for a Hong Kong IPO, with 10% of the shares set aside for local retail investors and the remaining 90% targeted at institutional accounts.

Following the IPO, the Chinese government will own close to 70% of Galaxy Securities through Central Huijin Investment, an investment company that holds stakes in various state-owned enterprises.

Because of its strong position in the brokerage market, Galaxy Securities has a greater exposure to A-share trading volumes than its peers, which in turn means that its earnings have come under more pressure as the domestic market has fallen during the past couple of years.

According to a syndicate research report, Galaxy Securities derived 54% of its revenues last year from brokerage commissions. Hong Kong-listed Citic Securities and Haitong Securities had a more balanced revenue breakdown with 23% to 25% coming from brokerage.

However, sources say that this also means that Galaxy Securities’ earnings have greater room for recovery once the A-share market starts to rebound. The report forecasts that income from commissions, which fell 22% in 2012, will increase by 30% this year and by 18% in 2014. This should help support a pickup in net profit by almost 48% this year and by 30% next year, it predicts.

The net profit fell 10% last year to Rmb1.42 billion, the report shows.

According to sources, Galaxy Securities is also expected to benefit from ongoing reforms of China’s securities market, including the introduction of new products, such as stock lending, stock repo, index futures and other derivatives, as well as from the expected consolidation in the industry.

At present, the company also has low leverage relative to its peers. This gives it the option to leverage up to help grow its margin financing business, where it already has a leading market share, and to support more trading in fixed-income, currencies and commodities (FICC), which is a business that is expected to grow faster than equities trading going forward.

In turn, this should help increase the company’s return-on-equity, which at 8.5% in 2012 was already among the highest in the industry thanks to its capital-light structure and high client deposits.

Increased leverage is something that is likely to happen across the industry, however, as more of the announced reforms kick in. And as the structure of the sector balance-sheet changes, analysts at one syndicate bank argue that asset-driven revenue growth will outpace the traditional fee-driven business such as brokerage and equity and bond underwriting. That would suggest that firms with a larger foothold in asset-driven businesses already, such as Citic Securities, ought to benefit the most.

Indeed, the key incentive for buying into Galaxy Securities’ IPO is likely to remain an attractive valuation. Observers have noted that it will need to come at a sizeable discount to Haitong Securities and Citic Securities, which are trading at 2013 price-to-book multiples of about 1.3 and 1.6, respectively, according to Bloomberg data.

The two firms have seen their H-share prices drop by 25% and 23% respectively this year in light of the challenging market environment.

As per the current timetable, the investor education for Galaxy Securities will last about one-and-a-half weeks, and the management roadshow and bookbuilding will run from May 2 to 10. However, a source said yesterday that the final timetable hasn’t yet been confirmed.

Still, this means that it could end up hitting the market at the same time as Sinopec Engineering after all. The latter, which is a spinoff from state-owned oil and gas major China Petrochemical Corp (Sinopec Group) that focuses on the construction of refineries, started investor education last Thursday and is also tentatively planning to launch the institutional bookbuilding on May 6. According to information provided to potential investors, the company is now looking to raise at least $2.1 billion from the sale of 30% of its enlarged share capital, which will make it the largest IPO in Hong Kong this year.

The largest so far is the $399 million IPO by Chinalco Mining International, a unit of state-owned Aluminum Corp of China and the owner of a greenfield copper deposit in Peru, which was completed in late January.

Citic Securities, J.P. Morgan and UBS are sponsors and joint global coordinators for Sinopec Engineering’s IPO. The other banks involved are Bank of America Merrill Lynch, Bocom International, CICC, Citi, CMB International, Deutsche Bank, Goldman Sachs, Haitong Securities International and HSBC. As with Galaxy Securities, the exact roles of the individual banks haven’t yet been confirmed though, and it is possible that one or two more banks will added to the list of joint global coordinators before the launch of the roadshow, sources say.

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