Fox Hu and Jonathan Browning
Companies going public in Hong Kong are getting the message that less is more.
Betting they could fetch higher valuations, Chinese companies hired sometimes dozens of banks to sell their initial public offerings in the last two years. The trend backfired, as the IPOs tended to underperform those using fewer bankers, and valuations were no higher, data compiled by Bloomberg show.
Now, if recent IPOs are an indication, companies are going the other way. Pork producer WH Group Ltd., whose IPO imploded in April after it enlisted a record 28 banks, is trying again, this time using just two main advisers in an effort to raise about $2.1 billion. Luye Pharma Group Ltd. hired only three banks when it went public in early July in an $878 million offering in Hong Kong. A return to fewer deal advisers should also spell good news for the banks, which have seen IPO revenues drop as they share fees with more competitors.
“People are voting that the structure is not working,” said Brett McGonegal, executive managing director of Hong Kong-based advisory firm Reorient Group Ltd. “For the banks, if you’re now splitting it with 10 times as many people, the economics change dramatically.”
Luye and four other companies that completed first-time share sales in Hong Kong this year of at least $500 million used on average seven advisers, or bookrunners. That’s the least since 2011 and down from an average of 11 last year, data compiled by Bloomberg show.
In the U.S., the 38 companies raising more than $500 million in the 18 months to July 1 also used an average of seven bookrunners, data compiled by Bloomberg show.
“Having too many banks will make it hard to coordinate, and conflicting messages may be sent out to investors in roadshows as a result,” Luye Chairman Liu Dianbo said in a July 9 interview. Citigroup Inc., Citic Securities Co. and UBS AG ran the sale for the drugmaker.
A Bloomberg review of 25 offerings over the past three years showed that the post-IPO performance of companies that used the most advisers tend to trail other deals.
The 12 companies that used an above-average number of bookrunners have underperformed theHang Seng Index (HSI) by an average 14.3 percentage points since they started trading, data compiled by Bloomberg show. The remaining issuers trailed the benchmark by just 2.2 percentage points on average, according to the data.
Using lots of banks in Hong Kong is a relatively new phenomenon. In the decade through 2010, companies completing $500 million-plus deals in the city used an average three bookrunners, data compiled by Bloomberg show.
Then in 2012, bank syndicates ballooned as Hong Kong’s IPO market slumped to a four-year low, pressuring underwriters to chase deals. At the same time, Chinese firms were pushing into the city, and they were willing to accept lower fees and more junior roles on offerings to gain a foothold in the market.
Profitability of arranging IPOs dropped as a result, with fees last year falling to 2.2 percent of the deal size from 3.3 percent a decade earlier, data compiled by Bloomberg show.
Among issuers, weaker companies were hoping that having large underwriting syndicates pitching to investors would help them sell stock at above-market valuations, said Ronald Wan, chief China adviser at Asian Capital Holdings Ltd.
That didn’t happen, the Bloomberg review of deals showed. Among the five IPOs that were priced at the top end of their ranges, just one used a higher-than-average number of bookrunners: China Cinda Asset Management Co. (1359), a state-owned manager of bad loans.
The more-is-better theory backfired on issuers because the fees each adviser gets become so diminished that they have little incentive to put in their best work, Reorient’s McGonegal said in an interview after WH Group’s IPO withdrawal in April. The risk of investors getting different information from different bookrunners also increases, he said.
In the process of pricing an IPO, “there’s a give and take and you need consistent information and equal weight at the table,” McGonegal said. “The more people you put in the equation, the more complicated the equation becomes.”
Even on billion-dollar IPOs, companies should use at most six bookrunners, said Philippe Espinasse, former head of equity capital markets for Asia at Nomura Holdings Inc. and author of “IPO: A Global Guide.”
“Investors hate it when 10 to 15 banks call them for the same transaction in a very confusing way,” he said.
The case of WH Group, the world’s largest pork producer, offers insights into how an oversized bookrunner syndicate can hurt a deal, according to bankers who were involved in the IPO and asked not to be identified discussing a private matter.
WH Group initially sought a valuation of more than 21 times estimated earnings for 2014, said three people familiar with the process. In early discussions with potential cornerstone investors, it became clear that such buyers weren’t prepared to pay more than 18 times for the maker of Farmland bacon, the people said.
Cornerstone investors receive guaranteed allocations in IPOs in return for a pledge not to sell shares within at least six months.
Undeterred, WH Group chose to start the IPO without cornerstones, initially seeking as much as $5.3 billion. Faced with tepid demand, the company cut the size of the deal to $1.9 billion, then failed to complete the IPO as it drew insufficient bids. The day before the sale was pulled, Morgan Stanley, which was in charge of compiling orders, had sent an e-mail to fellow bookrunners telling them the offering was covered.
What went wrong? First, banks vying for more senior roles on the IPO and a greater share of fees may have persuaded WH Group executives to seek an unreasonable valuation, people who worked on the deal said.
The book-building process also suffered as there were last-minute withdrawals of bids from speculators, according to the people. It wasn’t until the final hours before the offer closed that it became clear that there weren’t enough orders to cover the deal, one person said.
For its second try at going public, WH Group hired just two banks as main bookrunners: Morgan Stanley and BOC International Holdings Ltd. This time, the company is offering shares at least 23 percent cheaper than in its April attempt, people with knowledge of the matter said yesterday. Spokesmen for WH Group and Morgan Stanley declined to comment.
Hong Kong’s securities regulator in 2012 backed away from a proposal to limit the number of senior IPO underwriters, or sponsors, amid resistance from the banking industry.
Having too many sponsors might lead to “fragmentation of work, gaps and overlaps,” the Securities and Futures Commission said in a 2012 consultation paper. “From the perspective of investors there appears to be no benefit in having more than one sponsor.”
The initial WH Group IPO flop shows the regulator should push ahead with the reform it proposed, according to the Asian Corporate Governance Association.
“The market was shooting itself in the foot, telling the regulator we can do this ourselves,” said Michael Cheng, the group’s research director and former head of listing policy at Hong Kong’s stock exchange. “It’s a stark reminder to the regulator that the market needs more hand-holding on this one.”