Guolian Securities flags attractive IPO valuation

Another day another Chinese brokerage as Guolian Securities launches its Hong Kong flotation and offers a compelling valuation to stand out from a crowded field.

Guolian Securities launched its Hong Kong initial public offering on Monday, pitching the HK$3.143 billion to HK$3.65 billion ($405 million to $471 million) deal at an attractive valuation in an effort to capture investors' attention at a time when markets remain extremely choppy.

Last week's A-share market collapse has not provided a firm foundation for the lead managers to try to build momentum and does not auger well for the overall sector's likely profitability in 2015. Guolian's small size relative to its peers – it ranked 45th of Chinese brokers by market share in 2014 according to Wind database – also means investors could easily overlook it.

However, they are likely to be attracted to the valuation it has been pitched at, which is not only coming at a considerable discount to its peers but is cheaper still when the firm's strong underlying financial metrics are taken into consideration.

The markets also showed signs of turning on Monday. On the mainland, the A-share market was closed for the Dragon Boat Festival holiday but in Hong Kong the Hang Seng China Enterprises Index rose 1.5%.

Larger H-share listed brokerages Citic and Haitong also turned in positive performances for the first time in a week.

Guolian is offering 442.64 million shares on a price range of HK7.10 to HK$8.25 according to a term sheet seen by FinanceAsia. This equates to 23.27% of the company's enlarged share capital and constitutes 402.4 million in new shares and 40.24 million shares via an NSSF sell-down.

There is no greenshoe, which as fund managers point out is a negative overhanging the deal since there will be no initial secondary market safety net. The group is believed to have chosen this option because foreign shareholdings are capped at 25% and it wanted to be absolutely certain of raising full proceeds.

Balancing this out is the attractive valuation range, which spans 1.45 to 1.61 times forward price-to-book and 8.74 to 10.08 times forward price-to-earnings. During pre-marketing, joint sponsors ABC International, Bocom International and Qilu Securities pitched the deal on a fair valuation of 1.87 times and 2.22 price-to-book and 10.51 to 12.49 times price-to-earnings.

This would give the company an equity valuation of Rmb13.209 billion to Rmb15.703 billion ($2.13 billion to $2.53 billion).

Big discount to peers

There are presently six Chinese brokerages listed in Hong Kong. The nearest comparable is China Central Securities (CCS), which, like Guolian, is a regional rather than national player.

The biggest difference between the two is geography. CCS is based in the populous but relative poor Henan Province. Guolian is based in Jiangsu Province and specifically the prefecture level city of Wuxi, the second richest in the province and China overall behind Suzhou.

CCS is currently trading on a 2015 price-to-book valuation of 2.28 times and p/e of 15.3 times. At the mid-point of its IPO range, this means Guolian is coming at a 32.9% discount in terms of price-to-book and 40.5% in terms of price-to-earnings.

Its IPO is also being pitched at a steep discount relative to the sector's H-share average. At the mid-point of the range, this equates to a 20.4% discount compared to the sector's 1.92 times 2015 price-to-book average and 31.4% relative to its 13.7 times 2015 price-to-earnings average.

CCS ranks as China's 39th largest broker with a market share of 0.66% in 2014 compared to Guolian's 0.55% according to Wind Database. Nevertheless, despite its small size, CCS is currently trading at a valuation premium to the rest of the sector.

It currently commands the highest 2015 price-to-book valuation at 2.28 times compared to Citic Securities and Haitong Securities on 2.1 times. Since it listed in June 2014, CCS has ranged from 0.8 to 3.1 times and averaged 1.4 times.

Where 2015 p/e is concerned, it ranks second to Citic on 15.3 times compared to 15.79 times for its larger peer.

The least favoured of the six is China Galaxy Securities on 1.63 times 2015 price-to-book and 11.19 times 2015 p/e.

CCS's relative strength may be partly attributable to the fact that the larger Hong Kong-listed brokerages have been the first port of call for investors looking to short the market as the A-share market fell off its lofty perch.

Over the past two weeks, Citic Securities has traded down 11.9%, Haitong 12.7% and China Galaxy 17.9%. By contrast, CCS has come down just 3.2% since June 8.

Huatai and GF Securities, which both listed on Hong Kong this year, have not put in a sparkling performance. GF is still up 9.9% from its HK$18.85 IPO price at the end of March but has fallen 16.64% since June 8.

However, Huatai Securities, which only listed at the end of May, has not done well at all. In retrospect investors went piling into a deal, which had fairly aggressive pricing at a time when the markets were on the verge of topping out.

The flotation briefly rose above its HK$24.8 issue price to HK$26.35 but has since come down. It is now 6.7% below its IPO price and closed 3.74% down on Monday.

Guolian's selling points

During 2014, Guolian was slightly more profitable than CCS, raking in Rmb715 million in net profit compared to Rmb562 million for CCS. From 2012 to 2014, profits have risen by a compound annual growth rate (CAGR) of 175.9% and for 2015 syndicate analysts forecast they will rise a further 72.7% to Rmb1.235 billion.

In its marketing materials for institutional investors, Guolian points out that many of its metrics are very strong compared to its six other Hong Kong listed peers. In 2014, its cost-to-income ratio ranked first at 55.9% compared to Haitong in second place on 58.5%.

Its net profit margin was just pipped by Haitong, which achieved 35.4% compared to Guolian's 34.4%. Lowest was CCS on 23.8%.

It is currently one of the least leveraged with a net leverage ratio of 3.3 times in 2014 compared to Huatai on 3.7 times (the highest) and GF Securities on 3.6 times.

However, as syndicate analysts point out, Guolian is more exposed to swings in the A-share market than some of its peers and therefore should be valued at a discount. In 2014, 35.4% of its fee income came from brokerage compared to 26.2% for Citic and 26.8% for Haitong, which have more diversified business models.

Guolian also wants to turn itself into a more diversified financial services company. In 2012, 64.9% of its revenues came from brokerage compared to 40.2% in 2014.

In the interim period, proprietary trading has grown in importance from 6.3% to 21.7%, as has asset management, which has jumped from 2.4% of revenues to 10.4%. Investment banking constitutes the remainder, dropping from 21.4% in 2012 to 17.1% in 2014.

Guolian believes it is not at risk from national brokerages eating into its market share because its clients have remained very sticky over the last five years with a 76.2% retention rate. At the end of 2014, it had 584,000 retail clients and 1,500 institutional clients operating through 55 branches, of which 26 were in Wuxi, 12 in wider Jiangsu Province and 17 nationally in Beijing, Shanghai and other tier 1 cities.

The group was founded in 1992 by the Wuxi Municipal Government.

Other deal terms

The deal should benefit from the presence of 12 cornerstone investors who have committed to taking up $170 million or 41.89% of the entire deal.

Nearly all are investment managers and comprise: China Life Franklin with $20 million, Coastal Capital with $20 million, Citic Capital with $20 million, Wind Info Hong Kong with $20 million, CSR Hon Kong with $15 million, Dong Yin Development on $15 million, China Re Asset Management on $15 million, Essence Securities on $10 million, Fund Resources on $10 million, Myriad on $10 million, Orient Minerva on $10 million and Xinhua Daily Group with $10 million.

The overall deal will have the standard 90% and 10% split between institutional and retail investors. Clawbacks could see retail investors take up to 50% of the deal in the event of a 100 times oversubscription ratio.

Pricing is scheduled for June 26 and listing for July 6. In addition to the joint sponsors, CMB International and CCB International are joint bookrunners.

In the coming week, the syndicate banks will be hoping markets continue to improve.

In a research report published on Monday, BOCI flagged that Rmb3.5 trillion of liquidity has come pouring into the A-share market during the first half of the year compared to Rmb900 billion during the second half of 2014.

But it attributes this to the central bank's loose monetary policy rather than a re-direction of household savings. "By calculating the funds needed to stabilise GDP growth at 7%, we believe the ceiling of financial system generated funds in the A-share market is Rmb3.8 trillion," it writes.

"If the PBOC ultimately makes even more accommodative moves to attain the 2015 M2 growth target of 12%, we estimate the financial system could see a further increment of about Rmb800 billion in supply."

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