The IPO process in Hong Kong, as I’ll explain in this note, has been a serial value-destroyer in the last couple of years and part, but by no means all, of the problem lies within the industry that greases its wheels.
It is investors though that must shoulder the final responsibility for a system that has resulted in serial capital destruction via both in-plain-sight first and harder-to-see but potentially larger second order effects.
A just-say-no policy with regards to IPOs, especially if adopted by larger institutional investors (for a while at least), might improve the situation.
Summary Conclusion
It’s been noted smart money is made selling shovels to prospectors, not by the prospectors. This seems to have been especially true with regard to Hong Kong IPOs in the last couple of years.
As A General Rule
Before I get to the data I’d like to remind that IPOs in general are a bad idea for investors; and an especially bad one for smaller investors. The main reason is simple; informational asymmetry.
If you’re not a part of the charmed-circle of arrangers, advisors, private-equity early stage investors, reporting accountants and inner circle of wranglers that have been involved, often with a company for many years before its listing, you’re an outsider. Yes, you’ll get an IPO-prospectus, but this is just a grand business plan; and when did you ever see one of those that concluded a business was likely to fail?
Even if you’re invited to join the in-crowd, perhaps you’re working for a major institutional investor, you’ll still only get the best parts of a story. You may be ‘wall-crossed’ (you sign a legal document in exchange for information before the IPO formally rolls. You may in exchange be asked for an informal commitment to subscribe), you may get a face-to-face meeting with the company management; but this will only take you a small way across the informational asymmetry chasm that exists when a company is listing. Sure, you’ll be better off than the general public; but not by much.
Hooray For Hong Kong!
IPOs are a particular topic of interest right now because Hong Kong has been so good at them of late.
“Following a strong third quarter, KPMG forecasts total IPO fundraising in Hong Kong to reach more than HKD 300 billion ($38.4 billion),” the consultancy said in its quarterly IPO review for Hong Kong and the Chinese mainland published last week.
That means Hong Kong should finish 2018 as the world’s top market for new listings, KPMG said.
CNBC September 24th 2018
Prior years haven’t been too shabby either. 2017 was a record for the number of new companies listed according to the Hong Kong Stock Exchange with 174-new additions (versus 81-the prior year, although the Exchange fell into third place, behind the NYSE and Shanghai, in terms of dollars raised). Both 2016 and 2105 were also banner years as this snippet for the December 27th 2016 edition of the South China Morning Post notes:
[The dollar amount was a bit of a disappointment] It is [Amount raised], however, still enough for Hong Kong Exchanges and Clearing to rank No.1 among global IPO markets this year [2016], the second consecutive year it has taken the top spot. The funds raised in Hong Kong, according to the data, beat Shanghai Stock Exchange in second place with US$16 billion and New York Stock Exchange on US$11.87 billion.
It’s been a great few years for the shovel-vendors; but what of the prospectors i.e. investors where all this new issuance, ultimately, ends up?
Seek Truth From Facts
A lot has been written about whether or not IPOs work for investors. The problem is much of this work comes from partisan boosters. A lot depends on whether you consider a small sample of big listings (which is what I’m about to do) or you examine the complete universe? Do you just track money raised or look at whole-firm value? Should you look at day-1 share price performance only or returns over a longer time frame; if so, over what period should you concentrate your analysis?
Depending on how your focus your lens you’ll see different pictures when you start to study the data. So I’m going to take what I believe is the simplest, most commonsensical approach.
Below is a list of Hong Kong IPOs that raised around U$1bn or more in new-issue proceeds from the beginning of 2016. The final Gain/Loss column is the difference between the IPO subscription price and last Friday’s (October 5th) closing price. I think that’s clear enough?
| Date | Short Name | Code | Funds Raised H$bn | U$ Bn. | List Price H$ | Last | Gain/Loss |
| 3/30/2016 | Ch. Zheshang Bk. | 2016 | 13.3 | 1.7 | 3.96 | 4.35 | 9.8% |
| 3/30/2016 | Bk. of Tianjin | 1578 | 6.9 | 0.9 | 7.39 | 4.24 | -42.6% |
| 7/8/2016 | DFZQ | 3958 | 7.1 | 0.9 | 8.15 | 4.88 | -40.1% |
| 7/11/2016 | CDB Fin. Leasing | 1606 | 6.1 | 0.8 | 2.00 | 1.38 | -31.0% |
| 8/18/2016 | Everbright Secs. | 6178 | 8.1 | 1.0 | 12.68 | 6.76 | -46.7% |
| 9/28/2016 | Postal Savings Bk. | 1658 | 56.3 | 7.2 | 4.76 | 4.72 | -0.8% |
| 10/7/2016 | CM Secs. | 6099 | 10.2 | 1.3 | 12 | 9.14 | -23.8% |
| 10/28/2016 | CR Pharma. | 3320 | 14.4 | 1.8 | 9.1 | 11.88 | 30.5% |
| 12/9/2016 | CSC Fin. | 6066 | 7.2 | 0.9 | 6.81 | 4.28 | -37.2% |
| 4/1//2017 | Guotai Junan Secs. | 2611 | 16.4 | 2.1 | 15.84 | 15.96 | 0.8% |
| 6/20/2017 | GZ R+C Bk. | 1551 | 8.2 | 1.1 | 5.1 | 5.25 | 2.9% |
| 7/19/2017 | Zhongyuan Bk. | 1216 | 8.1 | 1.0 | 2.45 | 2.32 | -5.3% |
| 9/28/2017 | ZhongAn Ins. | 6060 | 11.3 | 1.4 | 59.7 | 26.9 | -54.9% |
| 1/18/2018 | Bk. of Gansu | 2139 | 6.8 | 0.9 | 2.69 | 2.25 | -16.4% |
| 5/4/2018 | PA [Good Doctor] | 1833 | 8.8 | 1.1 | 54.8 | 49.5 | -9.7% |
| 6/26/2018 | Jiangxi Bk. | 1916 | 7.5 | 1.0 | 6.39 | 6.18 | -3.3% |
| 7/9/2018 | Xiaomi | 1818 | 42.6 | 5.5 | 17 | 14.28 | -16.0% |
| 8/6/2018 | Ch. Tower | 788 | 58.8 | 7.5 | 1.26 | 1.14 | -9.5% |
| 9/20/2018 | Meituan Dianping | 3690 | 33.1 | 4.2 | 72 | 67.9 | -5.7% |
| Sum | 42.5 | Avg. | -15.7% |
Most large Hong Kong IPOs (at least until last Friday’s close), as is clear from the above, haven’t worked out for initial subscribers. Fifteen of the above 19-listings are currently underwater and on average the losers in the list are down 23%. The few winners, on average, are up only 11%.
Ignoring the whole market and just looking at the above investors, since the beginning of 2016, appear to have lost 16% on U$42.5bn or just under U$7bn. Well, not quite. To be fair we should adjust the gain/loss amount by the funds raised. If we do that the damage is reduced to U$4.4bn.
Is this really a problem? U$4.4bn is a small number compared to Hong Kong’s total market capitalization which, at the end September, was H$32trn or around U$4.1trn. Yes, it is. As I’ll explain further on this may be just the tip of a value-destruction iceberg.
Fool Me Once..
Given the serial pattern of losses produced by IPO subscription in recent years investors should examine their own process before accusing shovel-vendors of chicanery. Nobody is forced to buy an IPO, right? Well, er..
Large institutions are particularly at gunpoint to subscribe for new issues if, as nearly all do, they advertise a strategy relative to a benchmark into which a new issue is likely to be included. The bigger the IPO the greater pressure to participate, almost irrespective of the investment case.
So far so sub-optimal. To this value-corrosive dynamic though now add the impact of index-ETFs. An index sensitive manager has at least the option to hold back at IPO time in the hope of a better price later. The manager of an index-ETF or other strictly-passive strategy may not feel discretion based on value is within their purview. Their clients entrust them funds with a specific mandate; ‘buy everything’. That would of course include IPOs, at almost any price.
Cost-Benefit
The shovel-vendors will argue money into their respective businesses is good for the economy, they employ people who feed families and they pay their taxes (we hope?); but lets take a quick look at some basic math.
In my table above there’s U$43bn of new issue proceeds that were brought in over the period. Let’s imagine the big enablers in aggregate were paid 2% for their services (they always ask for more, but usually settle for less).
They will therefore have received U$860m for their trouble; but we’ve already established AT LEAST U$4.4bn of investor’s capital has been vaporized in this process! The system is clearly a big net loser, no doubt; and even the hardest-charging partisan would have a problem defending this process which is so obviously flawed in terms of aggregate economic dis-benefit?
China, A Terrible Place To Invest. Hong Kong, Not Much Better
China’s A-share markets, so far this year, have been among the world’s worst performing stock markets. Hong Kong stocks haven’t done much better; and here’s how China and world markets look to a global investor from December 31st 2015 to last Friday (the period covered in the IPO table above).
S+P-500 +41%
Nikkei-225 +25%
FTSE-100 +17%
Shanghai A-shares -20%
Hang Seng China Enterprises Index +9%
Is it pure coincidence that one of the most active IPO markets in the world is the same place stock prices have, for several years now, so manifestly under-performed? Honestly, I don’t know; but it’s a moot point that surely deserves wider socialization.
In Conclusion
Hong Kong IPOs in recent years have been a mixed blessing. Arrangers have done well, and so too have companies lucky enough to list because, as a group, they’ve managed to raise funds at price levels lower than their long term average costs of capital (to put it politely). Investors have done badly though.
If we consider just IPO losses highlighted in this note, it’s clear, capital has been destroyed; and over the period covered there have been many more high profile but smaller issues whose performances in addition have been poor-to-terrible. China Literature #772 now down 16% (but up 80%+plus at launch?!), Razer #1337 now down 55% and Crystal #2232 now down 33% are just three examples that come quickly to mind; and these ‘direct’ losses may represent only a fraction of the ‘true’ cost to investors.
How much larger would today’s aggregate Hong Kong market capitalization be if recent IPOs had been more reliable winners? 1%, 3%, 5%? Those percentages translate to U$ amounts of U$41bn, U$123bn and U$205bn respectively and are, in all cases, way in excess of any economic benefit that might have accrued to arrangers and their respective ecosystems.
Selling shovels to prospectors may be a smart strategy, in the short term; but if prospectors turn up nothing but dust or only the smallest of nuggets year after year, eventually, everybody is likely to find themselves out of business.
Nial Gooding
Monday, October 8th 2018