Market underworld buzzes with pre-IPO placement deals
with Shirley Yam
Oil and gas producer PetroChina jumped 163.32 per cent on its first day of trading in Shanghai.
E-commerce company Alibaba.com saw a 192 per cent first-day jump in its shares in the Hong Kong debut.
The market for initial public offerings is red-hot. Wouldn't it be great if someone offered you a guaranteed supply of 100 million shares of the next hot share sale way before the deal was officially launched?
That's exactly what's happening now. In the past two weeks, private bankers and hedge fund managers have been getting 'pre-IPO placement' offers on two upcoming mainland issuers, though the official start of placements is still two weeks away.
In one term sheet of these offers seen by this columnist, the seller guarantees you 100 million A shares if you are ready to pay a 20 per cent premium and wait for a year to sell. Its H shares are also available but at a much lower premium.
Many of you will ask, but how can one strike a deal when he still doesn't know the market response? If it is expected to be a very hot offering, how can anyone guarantee availability of the stock?
Welcome to the underworld of initial offerings.
In this world, insiders are guaranteed stocks in return for favours. It can be the state-owned enterprise's management which has little to gain personally from the listing. It can be the financial controller who has chosen this investment banker instead of the other one.
It can be the local official who put a stamp on the paper that says the issuer has paid up all the taxes. It can be someone in Beijing whose single phone call turns the stern face of a regulator into a smiling one.
It can be the exporter who has backdated a purchase so the issuer's profit looks much better.
In a placement allocation, the issuer's management will have no problem dictating who should get what. Sponsors are trained to ask few questions.
The key question is how to cash in. Some will hold the equities in secret accounts with friendly brokers, taking some market risk. Some will pick the risk-free option - unload the share at a certain premium before trading or the placement even starts. This is where 'pre-IPO offering' originates.
The price varies with market conditions. It can be a fixed percentage ranging from 5 per cent to 30 per cent on top of the offer price, depending on whether the stock is traded in Hong Kong or in the mainland. It can also be a profit-sharing agreement.
Special arrangements have to be made since both Hong Kong and mainland regulations bar connection persons, such as company management, from getting shares in an offering.
For Hong Kong shares, it's straightforward. A special vehicle will be set up to subscribe for the shares and then the vehicle is sold.
When A shares are involved, it's far more complicated. First, the interested buyer has to find a major state-owned enterprise to do the subscription on his behalf. This is because only about 400 institutions, mainly fund houses and finance arms of major state-owned enterprises, are authorised to take part in a placement.
No hassle. 'For a service charge of around 5 per cent, the middlemen will find you a helpful SOE,' said a mainland investment banker. Some officials of state-held firms are happy to bring in the so-called 'risk-free service commission' for their companies on top of a handsome personal gain.
Second, all placement shares in the mainland have a certain lock-up period ranging from three to 12 months. That brings in additional risk: how to ensure all parties honour the under-the-table deals when the market goes south in an issue.
Of course, given the buoyant market and frenzy for offerings, nobody seems to worry much about that risk. 'With the scarcity of supply, clients are ready to pay a premium for a guaranteed slot,' said a private banker.
Don't assume this kind of dirty operations involves only the small fry.
'I have seen a single transaction involving 300 million shares of XXX [sorry, I have to cross out the name. All I can say is it's a major state-owned bank],' said a European private banker.
International investment banks act as the middlemen. Open emails are sent to solicit orders. Contracts are signed at law firms.
This is an underworld that has been operating in broad daylight for years now. Though fairness is at stake, regulators don't seem to be bothered, given that it's a game among the big boys.
What's interesting is how active this grey market has become recently and that foreign buyers are invited to buy A shares which used to be restricted to mainland private funds.
For the insiders, that's a signal to worry.
'When market confidence is high, it's impossible to get your feet in. Everyone keeps the stocks to themselves,' said a player in Beijing.
Now that these pre-IPO deals are floating around, does it tell us something about the sentiment among the privileged?