South of the Bordeaux
What a difference a few years can make. Initial public offering volumes are sharply down in Hong Kong, while some markets in Southeast Asia appear to be enjoying a revival not seen since the 1997 financial crisis.
I mentioned earlier in Money Post ('Russian IPO fizzle shows limit of HK global plan' on July 2) that much of this is due, at least in part, to the shrinkage of deal flow from China's giant state-owned enterprises. That flow has generated much of the steady fee income for IPO bankers since the mid-noughties.
However, not only have IPOs in Hong Kong become fewer and smaller, but their quality has, on average, arguably also headed south.
There are several reasons for this.
A small deal requires as much work as a large one, if not more, but obviously for a smaller commission pool. This, together with fee erosion driven by low supply, has translated into a drop in the quality of bankers handling the deals. Simply put, they can lack experience, leading to failures to spot the issuers' shortcomings. And even when these are known, they may lack the ability to communicate these facts to investors in a way that informs but keeps the deal together. In other words, if you pay peanuts, you get monkeys.
With the supply of IPOs drying up, banks have also been forced to chase deals they wouldn't have considered before. When I was an IPO banker in the early 1990s, the firm's underwriting committee would not touch any flotation bringing in fees of less than US$2 million. Few banks today can afford to be so sniffy.
Instead, bankers are going for a brutally pragmatic approach of bringing pretty much any deal to market, regardless of its flaws, and move on to the next if it fails. Greed and opportunism have taken over from impartial advice and putting clients' interests first.
According to the Securities and Futures Commission's (SFC) website, 86 houses are authorised to act as IPO sponsors in Hong Kong, up from 78 in October. Compare that with Singapore, where only 44 firms are licensed to work as issue managers (Singapore's version of an IPO sponsor).
Now, with only 81 newly listed companies in Hong Kong last year (including 12 that transferred their listings from the Growth Enterprise Market to the main board), and with the same established firms working on the larger flotations, many of Hong Kong's IPO sponsors rarely get a chance to do a deal. When these smaller brokers do get involved in an offer, the recent scandals suggest they lack experience to handle an aggressive client, or take a corner-cutting approach over due diligence.
The issue doesn't really apply to the bulge bracket firms, although they have sponsored their share of bad (and in some cases outright fraudulent) IPOs.
The SFC's move to build a more disciplined regime for IPOs and their sponsors is therefore welcome.
It's a shame, however, that Hong Kong doesn't seem to be heading the same way as Singapore. From August 10, Singapore will increase the thresholds for main-board applicants, almost doubling the minimum market capitalisation requirement to about US$120 million, and increasing tenfold the requirement for annual pre-tax profits made in any given year to almost US$8 million.
By contrast, issuers in Hong Kong can readily secure a main-board listing with a capitalisation of less than US$26 million equivalent, and profits of less than US$2 million per annum. At those levels, the difference between the exchange's two boards becomes rather blurred.
When these deals are completed, the consequences are often diminutive aftermarket trading volumes, no sell-side research following, and extreme share price volatility. Add to that the recent trend for club deals, in which large chunks of IPOs are taken up by corporates, strategic investors and friends and family shareholders, and it's no wonder investors are shunning new listings for placements or block trades - or simply looking at other markets.
Quality breeds quantity. So, in a parallel reference to the wine industry, get rid of the Yellow Tail; we want the Lafite back.
Philippe Espinasse, a former investment banker, is the author of IPO: A Global Guide (HKU Press)