Huatai pre-markets IPO at discount to A shares

Chinese brokerage likely to offer the same large discount as GF Securities to ensure flotation's success in the face of a long pipeline of equity deals from the sector.

Huatai Securities looks set to follow in the footsteps of GF Securities and offer a large discount to its A-shares to ensure the success of its Hong Kong initial public offering, which began pre-marketing on Monday. 

Recent equity offerings from Chinese brokerages have all been extremely well received in the primary market and traded up in the secondary. And early indications suggest that Huatai's forthcoming deal is also on course to attract strong demand from both retail and institutional investors.

However, investors remain keenly aware that a long pipeline of Chinese brokerages hope to raise billions of dollars to expand their equity capital with either new secondary share offerings or IPO's in Shanghai and Hong Kong. On top of this, the sector is trading at a historically high valuation and has recently been under selling pressure.

Both Citic and Haitong Securities have seen their H-shares slip since late April, while GF Securities has been flat over the same period. Only China Galaxy Securities has gone up, rising 8.4% since the day after its own recent $3.1 billion equity fundraising in Hong Kong.

Overall the sector's underwhelming performance has been in line with the overall Hong Kong equities market. The Hang Seng China Enterprises Index has retreated 6% since April 27, although the Shanghai Composite Index has been fairly flat over the same period.

For investors the key decision will therefore be whether the bull market is experiencing a temporary pullback, or has gone into reverse. Is the market taking a pause after an unsustainably fast rise driven by China's growing army of retail investors? Or are investors pricing in much slower GDP growth in China that will have negative longer-term implications?

The issue is particularly important for Huatai since its profitability and valuation have one of the highest correlations to market volumes and margin financing of all the Chinese brokerages. In 2014, 65% of its revenues came from brokerage commissions and margin loans. 

If more retail investors pour into the A-share market, pushing turnover ever higher, then Huatai's profitability will correspondingly increase.  But the opposite will happen if the market falls - perhaps due to stronger regulatory measures to rein in leverage, or if the Mainland's novice retail investors start to panic and stampede for the exits.

As one fund manager told FinanceAsia, "The Chinese government is clearly trying to control the mainland stock markets in the same way it is behind the scenes managing all these brokerage deals coming to market as well. Everyone wants this deal to succeed because of the long line of others behind it. So I expect this deal to be priced to go."


Huatai is already listed in Shanghai and has a current market capitalisation of Rmb159.5 billion ($25.72 billion). Its own analysts are forecasting a fair value of Rmb200 billion ($32.25 billion) on a post money basis after accounting for the impact of the new equity deal. 

Based on a 2015 net profit forecast of Rmb8.1 billion ($1.3 billion), Huatai's post money A-share valuation equates a forward p/e ratio of 25 times compared to a consensus pre-money, forward p/e ratio of 23.07 times. In terms of price to book, it represents 2.5 times on a post money basis.

A term sheet seen by FinanceAsia, says the base deal size for the Hong Kong offering will comprise about 20% of Huatai's enlarged share capital. There will also be a 15% greenshoe of primary shares. 

Using Huatai's own valuation and applying the same 45% discount investors secured from GF Securities leads to a Hong Kong IPO of about $3.5 billion, or roughly $4 billion if the greenshoe is exercised.

Like GF Securities, the discount will have two components. Firstly, it is likely to encompass the standard 10% to 15% IPO discount investors expect relative to fair value estimates.

Secondly, it will also reflect the differential between the H- and A-shares of other Chinese securities companies listed in both jurisdictions.

Citic Securities, China's largest securities company by assets, is currently trading at the narrowest discount. On Wednesday there was a 27.4% differential between its A shares and H shares. In Shanghai it was trading at 3.53 consensus price to book and at 2.77 times in Hong Kong.

Haitong Securities, the number two by assets, is trading on a 37% differential. In China it has a valuation of 3.66 times price to forward book and in Hong Kong 2.67 times.

GF Securities, which recently raised $4.1 billion from a Hong Kong IPO, is now trading at a 34.9% differential. In Shanghai it is valued at 3.9 times price to book and in Hong Kong at 2.89 times. 

Together, the three average a 33.1% differential. In terms of 2015 price to earnings, their H-shares are trading at an average of 17.3 times.


Over the past year, the stock prices of all Chinese securities houses have risen very sharply particularly between late October and early December when investors assessed the positive impact of the Hong Kong-Shanghai Stock Connect scheme. 

On a one-year basis, Huatai's A-shares have risen 319%, while Citic is up 270% and Haitong 286%.

Year-to-date the performance has been more muted. Huatai is up 16%, while Haitong is up 15.8% and Citic is pretty much flat. 

Huatai's A shares are now trading at a big premium compared to historical averages since 2010. This amounts to about 1.8 times price to forward book and 18 times price to forward earnings. 

The opening up of cross-border flows between Shanghai and Hong Kong has led to the whole sector being re-rated. During roadshows, Huatai's management are also likely to argue that similar plans to forge a link between Hong Kong and Shenzhen will lead to a second re-rating. 

It is certainly true that the introduction of the Stock Connect programme, combined with the promise of greater investment freedom for China's fund management industry, has sent average daily turnover soaring.

In 2014, the A-share market was averaging Rmb950 billion a day. In April, the figure had shot up to a record Rmb1.4 trillion. 

One issue which worries the regulators is how much of this trading frenzy is being driven by leveraged money. Official figures show that margin financing stood at Rmb1.8 trillion in April, equivalent to 3.2% of market capitalisation. 

However, analysts calculate that the combined weight of other informal channels such as umbrella trusts and stock loans may have pushed the total up to a much more worrying 15% of market cap.

Selling points

Citic and Haitong both tend to trade at a premium to the rest of the sector.

For example, Citic is three times more profitable than Huatai and its revenue base more diversified. Haitong is twice as profitable and is renowned for its operational efficiency. 

Huatai's 2015 profitability is likely to be flattered by the big spike in recent trading volumes. As such analysts are forecasting a doubling in profitability from 2014's Rmb4.539 billion net profit figure. 

This in turn marked a doubling from 2013's Rmb2.03 billion. 

Huatai is China's largest broker by market share with a 7.9% share in 2014. Citic was second on 6%.

However, it has also been able to expand its dominance, with its market share increasing from 5.5% in 2012 and again during the first three months of 2015 to 8.3%. 

It also ranks second in terms of margin finance with a 6.4% market share at the end of December compared to Citic's 7%. 

During roadshows, the company is likely to argue that it is in the process of successfully transforming itself from a commission-based brokerage to a diversified financial services provider, which has much more lucrative fee base. In particular, it wants to build on its position as China's top domestic M&A advisor (according to MergerMarket figures) and number two in terms of assets under management within collective asset management schemes. 

Its strategy has been to build as large a client base as possible even if this means putting the industry's commission fees under pressure. Huatai now has 6.8 million clients and led the way in bringing broking fees down by cuts in September 2013. Average fees now total 4.2bp as of end March.

A second big selling point is likely to be its e-platform. The group's President, Zhou Yi, comes from an IT background and was instrumental in establishing the group's online presence back in 2008. 

This means Huatai has led the way, rather than felt threatened, by the move towards e-trading. In 2014 its mobile platform, ZhangLe Fortune Path, was rated's top trading app. 

Usage has risen dramatically from the 300,000 downloads recorded last summer. As of end March, the app had received three million downloads. 

As a result, 42.5% of Huatai's brokerage clients have now used it and the group says its overall e-platform represented 93.3% of its stock brokerage volume in 2014. 

One of the main reasons for the IPO is to boost equity capital so Huatai can expand its margin finance business. As of end March, the group had Rmb95.8 billion margin loans outstanding. 

During roadshows management are also likely to highlight that Chinese brokerage houses still have plenty of room to leverage themselves up. Chinese brokers leverage ratios average between four and six to one compared to 10 to 12 times for global comparables. 

Huatai is currently conducting pre-marketing, which will wrap up in New York on Friday. Roadshows should follow the week after with listing before the end of May.

Similar to GF Securities, retail will be capped at a maximum of 20% and only if books are more than 100 times covered. 

Joint global co-ordinators are Huatai International, JP Morgan and UBS. Joint bookrunners are ABCI, BNP Paribas, Citigroup, China Merchants Securities, Credit Suisse, Deutsche Bank, Goldman Sachs, ICBCI, Morgan Stanley and Nomura. 




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