SJM not fully covered; Deutsche picks up the balance

Thousands of investors cancel their earlier orders in light of a legal challenge, leaving Deutsche Bank as the underwriter to cover the shortfall. But the bank hedges its position by passing on the exposure.
Deutsche Bank has been forced to buy a portion of Sociedade de Jogos de MacauÆs (SJM) $494 million initial public offering to ensure the listing would go ahead after thousands of investors accepted an offer by the company to withdraw their orders, leaving the previously fully-covered deal undersubscribed.

This unusual outcome confirms that many investors are still not entirely comfortable with MacauÆs largest casino operator û especially at a time when other casino plays are taking a beating and the broader stockmarket remains highly volatile û and suggests that SJMÆs trading debut today could be a real challenge.

Deutsche Bank, which was obliged to buy the SJM shares due to its role as sole underwriter for the IPO, has, however, transferred its exposure to other investors through a number of derivatives transactions. As a result it will not be impacted by any potential gains or losses in the secondary market and may not even have lost that much of its fees.

SJM made its unusual withdrawal rights offer to investors last week as it had to issue a supplementary prospectus to include information about a judicial review of the listing approval sought by the sister of SJMÆs controlling shareholder Stanley Ho. Since the request for a judicial review came after the IPO had already been priced, the company û and Deutsche Bank û thought it only fair to allow investors who had already bought into the deal a chance to reconsider their orders. They gave investors three days to make up their minds and postponed the trading debut until today from July 10.

According to an announcement to the stock exchange yesterday, 2,672 retail investors decided to withdraw their orders, which accounted for approximately 55% of the order amount initially received under the Hong Kong public offer. This meant the 10% retail tranche, which had previously been 1.17 times covered, ended up only 0.53 times covered. A small number of SJM employees also withdrew their orders, but this had no material impact on the subscription level of the 5% employee tranche, which was only 0.04 times covered to begin with.

The shortfall of demand in these two tranches was covered by allocating the remaining shares to international investors. There was no information about the amount of institutional orders that were withdrawn, but sources say at least some investors took the company up on its offer. Either way, with the international tranche only ômoderately over-subscribedö to begin with, there wasnÆt enough orders to take up the excess shares in both these tranches and cover the international offering at the same time. The result was that the international tranche was undersubscribed by 102.87 million shares.

Based on the IPO price of HK$3.08 per share, Deutsche would have had to pay HK$316.8 million ($41 million) to buy these shares, which compares with a fee (including brokerage) of about $14 million-$15 million that it would have received for arranging the IPO. But by æsyntheticallyÆ selling the shares on to other investors, it would have been able to recoup a large portion of the initial outlay, although it would have had to cover the cost of the derivatives transaction.

A source close to the deal says this was a good outcome for a deal that had been plagued by threats of legal action throughout the marketing period. He also noted that the fact that the deal was undersubscribed was a direct result of the offer to investors being one-way only. This meant that investors who had already submitted orders were able to reduce or cancel them, but Deutsche Bank wasnÆt able to bring in any new investors and investors already in the book couldnÆt increase their orders.

While this is definitely true, the core issue here surely is that the deal didnÆt attract more investors in the first place, coming as it did at a time of heightened investor scepticism towards IPOs in general. Many investors are also concerned about the increased competition in Macau and projections that SJM, which stems from Stanley HoÆs former casino monopoly, will continue to lose market share for some time yet.

The fact that Deutsche Bank was able to hedge its position by synthetically transferring the exposure to other investors indicates that there are other interested buyers. However, given that they chose not to invest during the IPO itself, it is likely that they required some degree of discount in order to take up the shares now.

Another potential concern is that some investors may have been hesitant to publically cancel their orders as part of the withdrawal offer, and may feel more comfortable making an anonymous sale in the market. If that is the case, it could add further pressure to the shares when they start trading today. The debut is already bound to be tough, coming as it does on the back of another volatile session on Wall Street overnight that saw the Dow Jones index close below 11,000 points for the first time in two years.

Meanwhile, the Hong Kong court of final appeal yesterday threw out an appeal by Stanley HoÆs sister, Winnie Ho, which challenged a lower courtÆs decision last week not to conduct a judicial review of the decision by the Hong Kong stock exchange and the Securities and Futures Commission to approve the listing of SJM. Winnie Ho has tried to stop a listing of SJM for years and has filed 37 pending lawsuits against SJM in Macau and Hong Kong, challenging, among other things, various aspects of the shareholding structure and an earlier group restructuring.

SJM had earlier said that even if the judicial review was to go ahead, it would have no further impact on the timing of the companyÆs trading debut, but the fact that this latest legal challenge was dismissed could still have a positive impact on investor sentiment. However, Winnie HoÆs spokeswoman told local media yesterday that Ho plans to take her call for a judicial review to the court of final appeal, suggesting that she wonÆt rest even though her main quest will have clearly failed when the company finally goes public today.
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