Investors say 'ok go' to Hong Kong IPOs

Poor secondary markets are not helping a throng of IPOs coming to the city, with AAG Energy, Red Star Macalline, Legend Holdings and Vital Mobile already in book building.
A commercial for China's Red Star Macalline by US rock band and You Tube music video sensation Ok Go
A commercial for China's Red Star Macalline by US rock band and You Tube music video sensation Ok Go

Signs of a rout in Chinese equities are providing an extremely poor backdrop for the large number of Hong Kong initial public offerings currently in the market, with investors consequently pushing for pricing towards the bottom end of indicative ranges.

The only exception appears to be Legend Holdings, where a compelling valuation and the group's very strong brand name has resulted in an institutional oversubscription ratio of fives times at strike (ie no price sensitivity) at the end of the second day of book building in Asia on Tuesday.  

The other two sizeable flotations in the market – for China's largest coal bed methane (CBM) producer AAG Energy and its largest home furnishings retailer Red Star Macalline – are both showing price sensitivity towards the bottom end of their respective ranges.

Both the Hong Kong and Chinese stock markets dropped again on Tuesday with the Shanghai Composite Index down 3.47% and the Hang Seng China Enterprises Index down 2.71%. The latter has now fallen 10.5% since its May 26 peak. 

In Shanghai, the market failed to get beyond Friday's 5,131.88 year-to-date high after the publication of draft regulations capping brokerages' margin fee business over the weekend. This regulatory move, combined with a raft of 25 new A-share candidates – potentially tying up an estimated Rmb6 trillion ($966 million) in funds – has bought the bull market to a halt. 

BOCOM International also published a research report on Tuesday arguing that a bubble in mainland equities is now at an advanced stage. "A prevalent strategy among professional fund managers is to follow the crowd, but flee if the market turns slightly sour," writes Chief China strategist Hao Hong.

"The average holding period of tradable shares in China is about a week compared with two weeks at the peak of the Taiwanese bubble in 1990," he comments. Everyone is busy looking for the greater fool."

Are they among the 10.7 million Chinese retail investors who opened brokerage accounts in May? Their presence helped push the month's average daily turnover up to Rmb1.56 trillion and margin financing up to Rmb2.1 trillion, equivalent to 3.3% of market capitalization.

Hao Hong adds: "As extreme returns with small possibilities pile up, gains must accelerate to compensate for excessive risk undertaking. But the probability to sustain such excess diminishes too, much like being dealt a straight flush every hand."

Legend Holdings

However weak market sentiment appears to be doing little to derail the IPO of Legend Holdings, one of China's most diversified and well-known investment holding companies. 

Cornerstones have taken up $950 million, or nearly half the $2.084 billion to $2.251 billion paper on offer, post greenshoe. Institutions are already showing strong demand for the rest.

The deal has been pitched with a fairly attractive valuation of 13.2 to 14.3 times 2015 consensus earnings, which places it at a discount to comparables such as Fosun International, which is trading at 18.9 times.

The valuation also incorporates a traditional holding company discount relative to Legend's major subsidiary Hong Kong listed Lenovo group, which is trading at 18.2 times 2015 earnings.

Lenovo has been one of the worst performing blue chips in recent weeks. This suggests investors have either been switching out of, or shorting the stock in anticipation of the parent's listing.

The world's largest PC company by shipments closed Tuesday at HK$10.86, down 2.69% on the day and 19.6% since May 21. 

Legend holds 30.6% of Lenovo but, even though it has less than half of the equity or voting rights, it consolidates the company into its results. In 2014, Lenovo accounted for 94.1% of its parent's revenues and 40% of Legend's Rmb4.16 billion in profit attributable to equity holders of the company. 

Net profit has grown by a compound annual growth rate (CAGR) of 34.8% from 2012 to 2014 but is forecast to record a big jump in 2015 thanks to the IPO proceeds.

The base offering comprises 15% of the company's issued share capital and constitutes primary shares. There is also a 15% greenshoe.

The price range has been set at HK$39.80 and HK$43 per share, with 405.88 million shares on offer post-greenshoe.

Joint sponsors are CICC and UBS. Pricing is scheduled for June 19, with listing on June 29.

Red Star Macalline

The company known as China's IKEA has also opened book building for an IPO that could raise between HK$7 billion and HK$8.3 billion ($901 million to $1.07 billion) if the greenshoe is exercised. 

The deal is being pitched on a price range of HK$11.18 to HK$13.28 per share, which equates to a syndicate consensus p/e range of 13 to 15.5 times 2015 net profit of Rmb2.54 billion.

This represents a discount to better-known offline retailers such as Gome, which is trading at 18.3 times 2015 earnings and big global comparables such as the US's Home Depot and the UK's Kingfisher, which are valued at 24.22 times and 17.6 times respectively. 

Red Star will sell 625.13 million primary shares including the greenshoe, or 16.9% of the company's enlarged share capital. As a result, pre-IPO investor Warburg Pincus will drop from 16.9% to 14.3% pre greenshoe and will be subject to a one-year lock-up.

Five cornerstones have already committed to take up $330 million: Falcon Edge Global Master Fund on $100 million, Gree Electric $100 million, China National Building Material $50 million, Shandong State-Owned Asset Management $50 million, BosValen Master Fund $30 million.

Market conditions aside, the deal is reported to be going well. Sources close to the deal say the institutional order book was five times covered at the bottom end of the range at Tuesday's close in Asia and one times covered at the top end.

This includes a good mix of hedge funds and long-only funds particularly from the US.

Red Star Macalline is an extremely well known brand name in China but has nowhere near the same recognition internationally. Many fund managers are probably more familiar with Ok Go, the US rock group, which recently produced a commercial for the store group. 

Yet Red Star has succeeded where Home Depot and Kingfisher failed. Both got their business models wrong, with the former pulling out of China in 2012 and the latter selling a majority stake in its Chinese business last year. 

The two global giants failed to grasp that Chinese shoppers prefer do-it-for-me (DIFM) rather than do-it-yourself (DIY). As a result, Sweden's IKEA and Kingfisher's B&Q held market shares of just 0.5% and 0.2% in China at the end of 2014.

By contrast, Red Star Macalline ranks as China's largest home furnishings and building materials retailer with a 10.8% market share of chain retail malls in 2014. 

It has seen net profit grow by 25.4% between 2012 and 2013 and then 35.3% between 2013 and 2014. Over the next 12 months, net profit is forecast to drop to 15.4%, which suggests the company's fast growth phase is now over. 

As of end-December, the group had 158 malls across China occupying 10.5 million square metres. However it also has a big pipeline of 25 portfolio shopping malls, which tend to be clustered in tier one and tier two cities, plus 359 managed shopping malls in tier three cities and below.

During roadshows, the company's management has argued that, while e-commerce is important, big ticket furniture shopping is still conducted offline. This is because Chinese customers prefer to deal with a consultant to customise their purchases. 

In the three months to March 2015, 66.2% of revenues were derived from retail shoppers and 30.9% from wholesalers. 

Pricing of the IPO scheduled for Friday June 19 with listing on June 26. 

Joint sponsors are CICC, Goldman Sachs and Morgan Stanley, with the addition of Citigroup and CMS as joint global co-ordinators.

Joint bookrunners are BNP Paribas, CIMB, Cinda International, CMB International and ICBC. Joint lead managers are China Galaxy Securities, DBS and Shenwan Hongyuan Capital.

AAG Energy

Pricing for a HK$2.6 billion to HK$3.2 billion ($339 million to $418 million) offering post greenshoe is scheduled for Asia's morning on Wednesday. 

China's largest CBM producer has been offering 761.4 million shares of which 87.3% are primary, plus a greenshoe of 114.2 million secondary shares. Five cornerstones have taken up $229 million of the paper on offer.

If the greenshoe is exercised, selling shareholders will include Citic CDB, Warburg Pincus, Baring Private Equity and the company's chairman Dr Zou. Post deal, pre greenshoe Warburg Pincus will be diluted from 29.9% to 25.3%, while Baring will go down from 25.1% to 20.7% and Dr Zou from 8.4% to 5.9%.

Indications suggest the deal will price towards the bottom end of its HK$3 to HK$3.7 range. This represents a 2015 EV/Ebitda valuation of 8.5 to 10.6 times. 

Other publicly traded Chinese CBM producers such as London-listed Green Dragon Gas are trading at elevated 2015 EV/Ebitda multiples of up to 32 times. However, an Asian comparable such as Indonesia's Medco Energi, which also extracts gas from coal beds, is valued at 4.4 times.  

AAG Energy is China's leading CBM producer with a majority interest in two concessions called Panzhuang and Mabi in the country's most active basin, Qinshui Basin. At the end of 2014, it had proven and probable 2P reserves of 625 billion cubic feet and 3P reserves of 1.65 trillion cubic feet.

It is estimated that China overall has 384 trillion cubic feet of recoverable reserves. 

Post greenshoe, AAG Energy will sell 26.4% of its enlarged share capital. Listing is scheduled for June 23.

Joint sponsors are CICC and HSBC.

Vital Mobile

Haitong International is acting as sole sponsor of a HK$543 million to HK$748 million ($70 million to $96 million) IPO for Chinese smartphone manufacturer Vital Mobile Holdings. The deal, which is scheduled to price on June 19, comprises 244.375 million shares post greenshoe.

The deal is being pitched in a range of HK$2.22 to HK$3,06 per share, with three cornerstones taking up $15 million. They comprise Truly International on $5 million, Sun Xu on $5 million and Vast Right also on $5 million. 

The company is offering 28.75% of its enlarged share capital post greenshoe and is valued on a trailing p/e multiple of 10.7 to 13.8 times 2014 earnings of Rmb156.225 million. This puts it at a discount to a larger comparable such as Hong Kong-listed ZTE Corp, which is trading at 25.85 times 2014 earnings.

Vital Mobile ranked as China's fourth largest ODM smartphone manufacturer by exports in 2014 and has seen profitability grow quickly. Net profits more than doubled from 2012 to 2013 – rising from Rmb35.76 million to Rmb82.87 million.

They almost did the same again in 2014. 

Listing is scheduled for June 26.

Deals in pre-marketing

China's largest integrated health care solutions provider by revenue began pre-marketing an IPO last Friday. Beijing-based Universal Medical Financial & Technical Advisory Services is hoping to raise up to $500 million from the deal, which represents 25% of its enlarged share capital pre greenshoe.

Goldman Sachs and Nomura are joint sponsors of the offering, which will open book building on June 22, with pricing scheduled for June 30 and listing on July 9.

The company is planning to sell 423.189 million primary shares with a 90%/10% institutional retail split. The greenshoe also comprises primary shares.

Based on its 2014 net profit of Rmb456.6 milllon ($73.56 million), the deal is being pitched on a trailing p/e multiple of about 27 times earnings. 

Joint bookrunners are CLSA, CCB International, CMS, ICBC International and VMS.

Next in line is the IPO of another Chinese brokerage, Guolian Securities. Pre-marketing began on Monday under joint sponsors ABC International, BOCOM International and Qilu Securities.

The group is the largest brokerage in and around Wuxi, one of Jiangsu Province's biggest cities. In 2014 it recorded net profits of Rmb730 million. 

This suggests the group is likely to have a market capitalization of around $1.13 billion to $1.5 billion based on a 2014 earnings multiple of 10 to 13 times.  China's smaller listed brokerages Guangfa and Galaxy are currently trading around 16 to 17 times 2015 earnings. 

In New York, wealth manager Jupai Holdings has also filed to raise up to $100 million from an IPO. Credit Suisse and China Renaissance are joint lead managers for the New York Stock Exchange listing.

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