Capital squeeze pushes Chinese brokers into listings
Mainland brokerages are lining up to float and raise billions in a bid to deal with capital constraints caused by plunging profitability
Mainland brokerages, undeterred by the worst performance among the world's major stock markets, are seeking to raise more than US$6.2 billion from initial public offerings as capital constraints squeeze their operations.
Guotai Junan Securities, the mainland's third-largest brokerage by revenue, is among six securities firms awaiting approval to sell shares for the first time, according to filings posted on the regulator's website. They will be competing with about 600 companies seeking capital in a market where equities are trading near record-low valuations.
The IPO plans highlight their quest for capital to fund an expansion into new businesses and avert what Guotai Junan terms "a survival crisis" for the industry. Mainland securities firms, which make most of their money executing trading orders for retail clients, have seen profitability plunge to about an eighth of 2007 levels as trading commissions drop amid investors' disenchantment with equities.
"Now is definitely not a good time to seek listings," said Fanny Chen, a Hong Kong-based analyst at Haitong International Securities Group. "But for Chinese brokerages, low valuations aren't the biggest concern as they're badly in need of capital."
The firms need the funding for new, capital-intensive services such as offering clients securities lending and margin financing.
Lending securities to clients is crucial for the brokerages to facilitate short selling. Margin financing allows investors to buy securities using credit.
Reviving the firms' profitability and allowing their entry into these new businesses is vital for the development of capital markets in the country at a time when Chinese companies need financing and advisory services to further their global ambitions.
The China Securities Regulatory Commission said in May it intends to "build modern investment banks" that are competitive and influential globally.
"If China wants to be a credible financial centre and capital market moving forward, the ability to offer a full range of financial instruments is going to be essential," said Bonn Liu, a Hong Kong-based partner at accounting firm KPMG China.
"As Chinese corporates become bigger and more global, it makes logical sense that the investment-banking industry will follow suit."
Policymakers in China historically have given the bulk of their attention to the commercial banking industry, which is dominated by government-controlled lenders. As a result, brokerages, many of which are also owned or backed by the state, accounted for 0.8 per cent of China's 192.9 trillion yuan (HK$242.34 trillion) in financial assets at the end of last year, compared with banks' 78 per cent share, according to central bank data.
The brokerages' income growth also has been muted by the lacklustre performance of the nation's equities: market valuation as a percentage of gross domestic product - a metric favoured by Warren Buffett to gauge whether stocks are overvalued - dropped to about 42 per cent last year from 123 per cent in 2007, according to CSRC data.
In the first six months of this year, the equity benchmark Shanghai Composite Index fell 3.2 per cent, becoming the worst performer among the 46 developed and emerging markets tracked by MSCI. Chinese equities are trading at about 10 times earnings, close to the record low in April of 9.8.
The lack of appetite for mainland equities by domestic investors does not bode well for the firms' biggest business or their IPO prospects.
Stockbrokerage generated about 48 per cent of the industry's total revenue last year and accounts for as much as 90 per cent of income for smaller firms, according to Orient Securities, one of the six companies planning an IPO. The business has been under pressure as the average trading volume on the mainland's two main stock exchanges dropped 24 per cent last year from 2009, data shows.
Shares of the 19 publicly listed mainland securities firms retreated an average 10 per cent in the first half. Citic Securities, the largest by market valuation, dropped 10 per cent in Shanghai trading, while No2 Haitong Securities plunged 19 per cent.
"Traditional brokerages are facing a survival crisis," Zhao Xianghuai, a Shanghai-based analyst at Guotai Junan, wrote in a May 19 note. "China's securities industry is now in a 'big market, small industry' situation: its business model and asset size do not match the future growth prospects for the capital market."