The Wild, Wild East: 12 Snapshots Into China's Roller Coaster IPO Market

China Roller Coaster

While the rest of the world nickels and dimes its way through the grunge of austerity (whether by federal decree or self-imposed wallet diets), Asia – and specifically China – seems to be the one place in this recession-riddled world where IPOs are still being minted by the dozen and Horatio Algers are still able to pull up those bootstraps and make billions in less than a decade. But aside from gratuitous myth-making, there’s no denying the numbers:

  • China’s GDP surged 11.9% in the first half of 2010
  • $51 billion worth of IPOs have been completed so far this year (including AgBank’s July offering)
  • Shanghai is now home to the world’s second largest stock market
  • $7.2 billion in estimated domestic savings in Mainland China

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So, why the alarm bells of an equity capital markets bubble? Because while new IPO’s may be faring extraordinarily well (beating China’s benchmark equity indices by an average of 33 percentage points during the first month of trading), they’re still somewhat of a black box when it comes to the volatility of their share value after spending some time cooling  their heels in the market.

First off, these new equity offerings are consistently accused of being overvalued. As shown especially with deals completed in 2010, firms have had to notch down the final share price from overly optimistic initial ranges. And, as explained by Wang Zheng, “All IPOs now have one problem: offer prices are too high to make any profit from the secondary market. If there isn’t any big discount on offer prices, there won’t be any opportunity.”

Secondly, Chinese investors seem to lack proper methodology in planting their money where it’ll grow. Because domestic investors can’t allocate their capital offshore and government restrictions on real estate purchases and mortgage issuance, the “It” investment trend of the moment is to buy up shares of new IPOs. This might mean a robust pipeline and fast money to be made with gunshot public listings, but it’s not necessarily sustainable in the long run as share values tumble.

Is the world hunching its shoulders for a re-run of 2008 on the tail of China’s equity binge? Here’s our guide to the good, the bad, and the reckless of China’s IPO landscape and what it might indicate for the future of your portfolio.

Opening Act: Sichuan Express Railway ($264 million)

Date: July, 2009

Sector: Industrials (Transportation Infrastructure)

IPO 101: Investors were hungry to get their hands on this deal -- shares tripled on the first day of trading (The Shanghai Stock Exchange twice halted trading due to 'unusual trading') . This toll-road operator raised $264 million selling 500 million new shares at $0.53 apiece (with the retail portion accounting for 70% and the institutional accounting for 30%). The Institutional portion was 388x oversubscribed.

Why does this matter? Sichuan Expressway's IPO re-opened China's IPO market after 10 months of government-enforced equity freeze. And while this may have been enough incentive to peak investors' interest, the fact also remains that transportation infrastructure is a major priority for the CCP they're not afraid to splurge upon -- and this means everything from bullet trains to urban subway routes to rural highways like the ones managed by Sichuan Expressways.

(Currencies converted to July 23rd value)

The Comeback Kid: China State Construction Engineering Corp. ($7.3B)

Date: July, 2009

Sector: Industrials (Construction and Engineering)

IPO 101: The world's largest IPO since 2008 priced at the upper tip of the indicated range of $0.58 - $0.62 and ended its first day of trading up 56.2% from the final deal price. China State divested a 40% stake in the company and apparently raised $1 billion more than it had intended to with the public offering.

Why does this matter? Because China State's IPO hinted that investor appetite for big IPO's post-2008 was roaring back (this was the country's 4th largest offering at the time). While investors may have been comparatively cautious putting their money on another mega-offering in the wake of 2008, the deal still valued China's largest builder of housing at 51.3x its 2008 earnings (the average floats around 30x) and valued the firm that built Beijing's Water Cube at $18.42 billion.

(Currencies converted to July 23rd value)

Doctor's Orders: Sinopharm Group ($1.13 billion)

Date: September, 2009

Sector: Health Care (Health Care Providers & Services)

IPO 101: SinoPharm, initially expected to raise $957 million priced at midpoint of $1.82 per share, ended up beating all expectations to price at $2.06 a share to raise a total of $1.13 billion on the HKSE. Buy-side personnel were hungry for a piece of the IPO pie -- the deal was 570x oversubscribed with a 35/65 retail-institutional investment split. The deal received orders from investors ranging from major financial players like Bank of China Ltd. and China Construction Bank (both claimed $25 million apiece from the deal) to major investors like Saudi Prince Alwaleed bin Talal and Hong Kong billionaire Li Ka-Shing. SinoPharm's parent firm, China National Pharmaceutical Group, retained a 51% stake in the firm.

Why does this matter? Because China's 1.3 billion citizens are expected to be the world's third largest health care market by 2011 -- not to mention the long-term growth potential of this domestic sector. SinoPharm, the largest health care supplier in China (capturing 10.8% of market share at the time), marked a high point in this growth. Its IPO came at the heels of the government's $124 billion health care reform bill to make drugs and services more accessible - and was valued at 25x SinoPharm's expected 2010 revenue (almost double the ratio for McKesson, the largest US drug supplier).

(Currencies converted to July 23rd value)

The Flicker that Started the Fire: Metallurgical Corp. of China ($5.13 billion)

Date: September, 2009

Sector: Industrial Conglomerates

IPO 101: 2009's second large IPO debut ended in a trail of tears as shares fell 11.5% from their issue price on the Hong Kong Exchange. While Metallurgical listed its shares both on the Shanghai and Hong Kong exchanges, investors were wary of overpricing and deemed the IPO to be richly valued given uncertainty over China's steel industry outlook at the time. One more thing to note - the offering's retail tranche (5% of the total shares offered) was 205x oversubscribed while the institutional portion was only 10x covered.

Why does this matter? Metallurgical's soporific IPO was the first of a series to disappoint on both the Hong Kong and Shanghai exchanges. And though major buy-side players like Och-Ziff and China Life Asset Management had publicly committed beforehand to buying shares, investors went lean on this this deal given a slowdown in domestic demand for steel (this firm was partially responsible for building the famed Bird's Nest). But stay tuned - this is only the beginning of a slow bursting of the Chinese IPO market in the latter half of 2009.

(Currencies converted to July 23rd value)

The Late Bloomer: Peak Sport ($221 million)

Date: September, 2009

Sector: Consumer (Textiles, Apparel, and Luxury Goods)

IPO 101: Possibly the worst debacle of the 5-IPO losing streak starting with Metallurgical and ending with Glorious Property Holdings. Shares on the HKSE closed 17% down from final deal price on the first trading day and deal shares were only 20x covered. Peak Sport, which manufactures sportswear and is most recognisable for its shoe brand, issued 420 million new shares at $0.53 (midpoint of the indicative price range of $0.46 - $0.59). The IPO still made a killing for Sequoia Capital's Asia branch, which invested a total of 26 million in the consumer goods firm and maintained a 10% stake after the offering.

Why does this matter? Because this deal shows, in ugly and naked terms, what could happen in the equity markets despite strong company revenue projections and a positive industry outlook. Peak Sport (which had just signed up Jason Kidd of the Mavericks as a brand ambassador) had more than doubled its profit in 2008 and was dubbed one of the most recognisable shoe brands on the market (along with Nike and Li Ning). The apparel industry itself was projected to grow 18% by 2013 within Mainland China. But apparently, once a slide has begun and investors smell blood, IPO appetite goes in for a beating.

(Currencies converted to July 23rd value)

The One that missed the boat on the real estate boon: Glorious Property Holdings Ltd. ($1.28 billion)

Date: September, 2009

Sector: Financials (Real Estate Management & Development)

IPO 101: Initially planned for a July 8 pricing date, Glorious Property didn't end up coming through with a deal close until late September -- with shares falling 15% on the first day of trading. The largest Hong Kong Exchange-listed IPO by a Chinese property company since SOHO China's successful 2007 offering (stocks traded 15% above the final IPO price at the close of the first trading day) issued 2.25 billion shares (30% stake) at $0.68 each, raising $1.28 billion total. The deal ended up pricing at the low end of the indicated range and was HKSE's fifth straight IPO flop of 2009 (beginning with Metallurgical Corp.). Backers included private equity powerhouse D.E. Shaw and Goldman Sachs, and the investor pile included China Investment Corp.

Why does this matter? Clearly, investors were by now fully aware that Q2 and early Q3 2009 boons in IPO offerings had created something of an equity bubble and shied away from actively purchasing new shares. As equity capital market conditions softened, the trading massacre accompanying Glorious Property's offering also made clear that investors were becoming bearish about Chinese real estate sector outlooks -- a clear cooling from the obvious optimism of two years prior.

(Currencies converted to July 23rd value)

Baring Asia's Prize Show Dog: Yingde Gases ($409 million)

Date: October, 2009

Sector: Materials (Chemicals)

IPO 101: Previously one of Baring Asia's portfolio investments, Yingde went on to publicly list 452 million initial shares on the Hong Kong Stock Exchange at an indicative price range of $0.78 - $1.02 per share (yielding a conservative P/E multiple of 12.8x - 16.8x based on 2010 earnings estimates). Shares of this Chinese supplier of industrial gases surged 10.42% after the first day of trading.

Why does this matter? Yingde Gases, which prides itself on being the largest domestic independent gas supplier (specializing in on-site gas supply) in China, rode to success amidst predictions of strong revenue growth (the firm expected production to double in capacity within 2 years) but also on the back of expectations for the growth of China's energy needs (expected to increase by 150% by 2020).

(Currencies converted to July 23rd value)

The Oriental Matawan: China Vanadium ($266 million)

Date: October, 2009

Sector: Materials (Metals & Mining)

IPO 101: China Vanadium, the largest non state-owned operator of iron ore in the Sichuan region, raised $266 million through selling 588.8 million H shares on the Hong Kong exchange (29.4% total stake in the firm). The deal, which was expected in August of that year to raise only $200 million, ended up pricing at the midpoint of the indicative price range and trading up 2.6% during the course of the first day, a modest but quietly triumphant rise given waning investor appetite at the time.

Why does this matter? Because the deal, which resulted in a windfall for Green Globe Investment (which sold 88.8 million of its own shares alongside new stocks being offered), once again displayed the attractive exit options Chinese firms going public might offer private equity and venture capital firms that committed themselves as shareholders on the Mainland.

(Currencies converted to July 23rd value)

The Runny Nose Dive: China Hydroelectric ($96 million)

Date: January, 2010

Sector: Utilities (Independent Power Producers & Energy Traders)

IPO 101: After several rounds of deal upgrading, China Hydroelectric finally sold 6 million units at $16 a piece (smack dab in the middle of the $15 - $17 indicative range) and raised just shy of 100 million. And although the greenshoe was indeed exercised to bolster initial trading on shares, the ADS portion of each share (each unit comprised of one ADS and one redeemable warrant - which could be redeemed for cash) tumbled 6% at the end of the first trading day. None of the Wall Street bulge brackets operated as underwriters or managers on this deal, which was run by boutique names like Broadband Capital and Merriman Curhan Ford.

Why does this matter? Again, this is yet another ambiguous warning signal for Chinese firms looking to push forward an IPO on US soil. Perhaps this might have been a confusing sell to investors given the state of the two-unit share offering, but for a firm that claims a 197% revenue increase in 2009 and operates within an industry that still has yet to attract hordes of competitors, the IPO disappointed in its execution and follow-through trading. This hydropower plant developer and operator aims to be largest of its kind in the PRC and was founded less than 4 years ago.

(Currencies converted to July 23rd value)

No more real estate deals PLEASE: Century 21 China ($87 million)

Date: January, 2010

Sector: Financials (Real Estate Management and Development)

IPO 101: Century 21 China, a franchise owned by IFM Investments (with Goldman having a minority stake) was one the rare Mainland firms that chose to list shares on the NYSE -- with a proper dose of accompanying drama. Originally hoping to raise $109.8M with an indicative pricing range of $9 - $11, the deal underwent a series of revisions to finally price at $7 per share, raising a total of $87 million after 12.5 million ADS's were sold. And the deal reportedly did well, trading up to $7.25 apiece on the first day.

Why does this matter? After the charades, a few unsettling questions come through. First, if Century 21 China owns 1300 franchise offices across 31 regions and claims to be strong household brand for both the mum and pop crowd as well as younger students looking for their first rental unit, why did it go through 3 rounds of price reductions to reach a final share price that was a full 22% less than the bottom line of the initial indicative pricing range? Second, being the rare case of a major ADS listing (for a US dollar-denominated share offering by a foreign-based firm), did the unwilling appetite from investors indicate that Chinese companies should stick to listing on the Hong Kong and Shanghai exchanges as opposed to the NYSE or NASDAQ? While Century 21 China may be expanding business in smaller urban areas, away from crowded markets like Beijing and Shanghai, the prospectus also writes that the real estate brokerage industry 'has low capital commitment requirements for small operations, lowering the barriers of entry for new participants'. Low barriers of entry? This recipe is ripe for a bubble burst.

(Currencies converted to July 23rd value)

The 30-Second-Boom-and-Bust: Huatai Securities Co. ($2.3 billion)

Date: February, 2010

Sector: Financials (Capital Markets Industry)

IPO 101: Huatai's IPO was the biggest initial offering in China since Metallurgical Corp's debut, raising $2.3 billion after selling 785 million shares at $2.95 (the low end of an indicative price range saddled between $2.95 and $3.24). The final deal figures are discounted from the original intended offering value of $2.9 billion, but still went on to trade up 5.3% at the close of the first day on the Shanghai Stock Exchange (despite the fact that the benchmark Shanghai Composite Index fell 0.3% that day). The deal was split 30% to institutional investors and 70% to the retail crew.

Why does this matter? Huatai's offering was the first to inject inertia into what was a slow start for 2010 SSE debuts (IPO's dropped an average of 28.5% on the first day of trading this year), and for good reason. One of the 10 largest brokerages by asset value amidst China's list of 107 securities companies (in 2007), Huatai's profit almost tripled in 2009 and wanted to use funds from the IPO to create an index futures product and pilot margin trading program on the Mainland. The financials sector is ready for development and expansion in China. 107 securities firms is paltry compared to the 8,430 FDIC-insured commercial banks operating in the US as of 2008.

(Currencies converted to July 23rd value)

Nobody appreciates waste water like they should: Chongqing Water Group Co. ($511 million)

Date: March, 2010

Sector: Utilities (Water)

IPO 101: Chongqing Water Group became the largest quoted water company in China after its IPO raised $511 million selling 500 million shares at $1.02 each (top of the price range). The deal was 67x covered and apparently sported a rather cheap valuation (P/E valuation stood at 34.9x -- reportedly a comfortable margin below CWG's direct competitors). By the end of the first day of trading, shares had climbed a 74%.

Why does this matter? Because this deal's just the tip of the iceberg when it comes to Chinese equity and potentially debt offerings that support firms seeking to protect the environment. The 12th 5-year plan specifically prioritised water treatment as a favoured sub-topic of its push for going green, presumably aiding Chongqing Water's strong performance in the market as investors tusseled for more shares of the firm that claims majority market share in Chongqing's waste water treatment initiatives. The firm's revenue has grown 9 times since its founding in 2001 -- testimony to the fact that expanding urban metropoles that attract rural migrants at hectic rates provide huge potential for clean utilities infrastructure growth.

(Currencies converted to July 23rd value)

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