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HONG KONG -- Back in the days of the technology-stock boom, U.S. investment
bankers were criticized for handing out all-but-sure-money IPO shares to favored
clients like candy. In Hong Kong, a similar feeding frenzy is happening with
China's hottest initial public offerings of stock.
Take Bank of China Inc.'s IPO, which had a strong debut Thursday. The deal is
expected to raise as much as US$11.2 billion, making it the world's biggest IPO
in six years. The marketing document for the shares cites 12 "corporate
investors" which each were given a chance to buy the stock at the IPO price, as
long as they don't sell for a year. Among the lucky few are some of Hong Kong's
celebrity tycoons or companies they control, including the flagship businesses
of the bluest-blood of them all, Li Ka-shing.
This is the way business has been done in Hong Kong for years, mainly because
investment banks felt they needed to use star power to boost the credibility of
the IPOs of Chinese enterprises that weren't household names to global
investors. The tycoons' names and cash attract more capital, increasing the
IPO's chances of success.
But critics say the practice has outlived its original purpose, given that
China is one of the hottest investment opportunities in the world. Far from
being an obscure backwater company in need of name recognition, Bank of China
has drawn tremendous demand globally and locally for its new shares. The banks
overseeing the deal -- Bank of China affiliate BOC International, Goldman Sachs
Group Inc. and UBS AG -- received applications to buy shares from more than 10%
of Hong Kong's population. Including international and institutional demand,
offers to buy totaled $150 billion -- well over 10 times the value of the
available shares. Not surprisingly, the shares popped 15% on their debut.
Yet the dozen corporate investors ended up with about 15% of the offering,
with each buying as much as $180 million of stock at the IPO price.
"If you're talking about corporate governance, in general, it is not a good
thing," says Qiao Liu, a professor of business and finance at Hong Kong
University. "Those Hong Kong tycoons are receiving preferential treatment in the
IPO process."
Critics such as Prof. Liu see the practice as favoritism toward the city's
elite at the expense of individual and institutional investors, who are often
granted only a minuscule proportion of the shares they seek. The tycoons can
lock in what other investors have to compete for -- a hefty slice of some of the
world's most-important deals at the IPO price.
With a long list of Chinese companies queuing to list in Hong Kong, there's
no sign the practice is abating. Mr. Li and his peers in the Bank of China IPO
-- including Lee Shau Kee of Henderson Land Development and Cheng Yu-Teng of New
World Group through Chow Tai Fook -- are into other China deals big and small.
Mr. Li's companies have bought into five of China's 10 biggest IPOs. His
conglomerate, Hutchison Whampoa Ltd., which is involved in everything from ports
to telecommunications, invested in Tianjin Port Development Holdings Ltd.'s $140
million offering in May. Mr. Lee and Mr. Cheng both bought into the $63.2
million offering earlier this year of Nine Dragons Paper (Holdings) Ltd.,
China's largest containerboard maker by output.
Both of those deals drew far more subscriptions from investors than there
were shares on offer. And their shares have brought in decent returns. Tianjin
Port's shares are up 20% from their offering price, while Nine Dragon shares
have risen 85%.
Handing out chunky pieces of a hot IPO has led to trouble in other markets.
Several years ago, U.S. regulators cracked down on a practice known as spinning,
in which investment banks steered hot IPO shares to preferred clients in hopes
of winning lucrative advisory work from those clients. The practice spanned Wall
Street and padded the portfolios of top executives from companies such as
WorldCom Inc., eBAY Inc., and Yahoo Inc.
Without admitting or denying wrongdoing, a Credit Suisse Group unit paid $200
million to settle charges brought by regulators over practices that included an
IPO allocation program associated with star banker Frank Quattrone. (Mr.
Quattrone's 2004 conviction on charges of obstructing an inquiry into another
IPO issue recently was overturned; he is awaiting a possible retrial. He
announced Thursday that securities regulators had agreed to withdraw civil
charges against him related to his IPO allocation practices.)
The Hong Kong allocations don't contravene local securities regulations.
Unlike what happened during the tech boom in the U.S., in Hong Kong bankers
overseeing the IPOs disclose in public documents exactly who is getting how much
on what terms. The city's Securities and Futures Commission referred questions
to Hong Kong's stock exchange, which didn't reply to questions.
"I don't see that there is anything wrong with it as long as there is proper
disclosure," says David Webb, a corporate-governance advocate in Hong Kong who
is also an exchange board member. Hutchison says it joins in some IPOs from
"time to time" as investments. Mr. Lee and Mr. Cheng were unavailable to
comment.
The tycoons take on risks that other investors don't, such as holding the
stock for the lockup period of six to 12 months, unlike what happened in the
1990s in the U.S. when IPO investors could immediately flip their shares for
quick profit. Bankers involved in Hong Kong IPOs point out that the corporate
investors' presence helps strengthen the IPO process by reducing the amount of
shares that have to be sold to the market, hedging against possible weak demand.
And the tycoons' local brand value may help to rally Hong Kong's individual
investors, who often try to emulate the famous investors' style.
"It puts the 'seal of approval' on the IPO and gives confidence to
investors," says Mark Mobius, portfolio manager for emerging markets at Franklin
Templeton Investments.
Having the backing of big names is also a way to signal support for China's
privatization process, especially in times of trouble. When the 2002 IPO of Bank
of China's Hong Kong unit looked like it might flop, Mr. Li and the other
tycoons pledged to buy shares. The unit, BOC (Hong Kong), is a major lender to
most of the city's biggest developers; its shares are up 73% from the IPO price.
Supporting the IPOs "is a good way to maintain good relations with the
Chinese government, which is crucial for [the tycoons'] business operations in
the mainland," says Hong Kong University's Mr. Liu. "Also, it might turn out to
be a profitable deal afterwards."
Generally, Chinese IPOs have done well for their investors -- even with the
one-year lockup. The average one-year return on Chinese IPOs was 21% in 2004 and
37% in 2003, according to market data provider Dealogic. For the seven Chinese
companies that sold shares in Hong Kong in the first five months of last year,
the average one-year return was 69%.
The question remains whether today's offerings get as much out of the
tycoons' role as the tycoons do.
The practice began in 1997 with the $4.2 billion IPO of what is now China
Mobile (Hong Kong) Ltd. At that time, Asian currencies were weakening, regional
markets were sliding and China's then-biggest stock offering was on shaky
ground. To build confidence in the unknown telecom company, the underwriters --
Goldman Sachs and China International Capital Corp. -- turned to Hong Kong's
rich and powerful, who had cultivated close ties with China.
A club of 12 investors, comprising many of the same parties as in the Bank of
China deal, agreed to buy 45% of the transaction at the IPO price and to hold
those shares for at least a year. That helped fuel demand from individuals for
about 30 times as many shares as were offered, and substantial interest from
global institutional investors.
Today, the Chinese business landscape is much more mature, with investors
world-wide desperate to put money in the country's booming economy. China Mobile
has grown into the world's biggest cellular-phone company by subscribers,
earning $6.7 billion last year on $30 billion of revenue. "When the practice
started, the markets were more difficult, and there were more concerns over
transparency. These companies now have excellent track records," says Tim
Dattels, managing director at Newbridge Capital and former head of Asian
investment banking at Goldman Sachs. "The markets have moved
on."
