Market principles melt in China’s IPO reform

Five companies halt their listings as the CSRC tweaks its new rules, leading to worries that the regulator will continue to meddle with the process and ignore market principles.

Mainland China’s IPO reform is barely a week old and already the wheels could be falling off.

The China Securities Regulatory Commission is in the spotlight over whether it is being too protective and failing to let market forces do their thing, a supposed aim of the changes.

With the IPO market only reopening this month after a 14-month suspension, the securities watchdog surprisingly stepped in last Friday to stop one of the first planned deals.

Jiangsu Aosaikang Pharmaceutical, a drug manufacturer founded in 2003, had almost finished its Rmb4.05 billion ($664 million) offering on ChiNext — the Chinese version of Nasdaq — when things turned sour.

The CSRC followed that by introducing further new measures to strengthen regulation on Sunday night.

Five companies then announced on Monday they would halt their listings and adjust the timetable for their IPOs, catering to the changes in the regulator’s new measures.

The five include the $28 million IPO of healthcare company CiMing Health Checkup Management Group. The deal was close to being priced and would have started a roadshow to retail investors on Monday.

Some investors were concerned the five might set their IPO price too high and that existing shareholders could sell a big tranche of their shares, which often signals a lack of confidence.

The CSRC, in its amendments announced on Sunday, said it would check issuer price inquiries and roadshows selectively and halt issuance if any misleading information is released to the market.

It will also ask issuers and bookrunners to highlight investment risks through company statements if they sell shares at valuation of a premium to peers.

The CSRC, along with the Securities Association of China, said it will strictly monitor and control the institutional investor pricing procedure in IPOs.

All this doesn’t sound particularly conducive to a market-driven approach, a key pillar of the original reforms, announced on November 30.

The latest actions by the CSRC has reignited debate – as if it had abated – as to what extent the market will be allowed to play a “decisive” role in the IPO process, a promise of the regulator throughout the reform process.

Investors and analysts see the latest measures as a sign that Beijing is still very cautious in pushing ahead with its newly announced reform.

“The new measures put more limits on the offerings,” said an investment banker with a large domestic brokerage. “The situation becomes more complicated now.”

Although it is unclear who actually made the first move in stopping Aosaikang’s IPO, sources later confirmed the decision was made by the CSRC.

“The CSRC is under enormous pressure,” said a source close to the regulator. “The public had strong negative opinions towards this deal.”

It is not clear why the regulator asked to postpone the deal — it had already priced according to the rules — and the regulator does not plan to further look into the transaction for any misbehavior.

One source said it was because “people think the valuation is too high”. Some local Chinese media, including China Central TV station, questioned the company for “bloodsucking” behavior, suggesting that the group was too greedy in pricing.

At a press conference on Friday, Deng Ge, a spokesman with the CSRC, highlighted that issuers and bookrunners needed to balance interest between the companies and existing shareholders, retail and institutional investors, and new and old stakeholders.

“They need to maintain market fairness and make reasonable decisions in the split between new and old shares, institutional and retail tranches and the underwriting fees. They need to pay attention to interest of both sell and buy sides, and protect the middle-and small-sized investors.”

“Marketisation does not mean [leaving] it alone,” said Deng.

Aosaikang’s case is a good example.

The company priced the 55.466 million shares at Rmb72.99 each, representing a price-to-equity ratio of 67 times, 39.7% higher than the average of five peers of 49.01 times and 21.2% higher than ChiNext’s average of 55.31 times for drugs companies, according to a company statement.

The price is also higher than investors’ general expectation, as the mid-point of all the valid institutional subscriptions is about Rmb61.05.

The issuer made efforts to justify its price in the prospectus with an annual growth rate of 40%-50% in net profit during 2013. It estimated a 2013 P/E of 46 times and a 2014 P/E of 32 times.

“The 67-times P/E is a little expensive but the valuation in the next two years is fine if the company realises the growth,” said a fund manager who failed to get any allocation of the shares.

Although some investors said the valuation was high, 361 institutional investors participated in the pricing consultancy process for orders of 2.657 billion shares, leaving the book more than 80 times covered.

“The deal was priced [correctly] after consulting prices in the market,” said a source close to the company.

Another criticism from investors is that the controlling shareholder sold too many shares.

The Chen Family, founders and controlling shareholders of Aosaikang, would have cashed out Rmb3.18 billion by unloading 43.6 million shares, or 39.3% of the enlarged share capital. The company can only raise funds of Rmb865.7 million.

According to the reforms, the CSRC allows existing shareholders who have held their stakes for more than 36 months to sell their stakes in the IPOs.

The Chen Family is the only shareholder that meets the requirement, and all the information was released in the prospectus.

Existing shareholders trimming a large amount of shares during IPOs is usually not a good indicator for investors as it may suggest weak confidence by them in the company.

This, of course, is not always a bad sign. The controlling shareholders of AIA and MGM China sold a big tranche of old shares through IPOs to investors (in AIA’s case, all the IPO shares were old from AIG).

“All in all, it’s a judgement by investors, not by the regulator,” said a Hong Kong-based corporate finance banker with a global investment bank.

Aosaikang said it would wait for a better time to restart the listing. But a source said it is also the CSRC’s decision about the timing of re-launching.

And what is clear in all this is that the regulator is still keen to jump in and make judgements on valuation and other parts of the process.


¬ Haymarket Media Limited. All rights reserved.
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