Tycoons are supposed to be smart. Yet, over 80 per cent of their investment in public offerings in the past four years is way below the offering price. How could they be that dumb?
Last week a good explanation arrived from the least expected source - the Hong Kong stock exchange.
In a guidance letter, the exchange said it "does not allow any direct or indirect benefits by side letter or otherwise, other than a guaranteed allocation of shares at the IPO price, to be given to cornerstone investors".
Among the side deals are promises to buy back the shares after listing; an assurance that the issuer will re-invest the IPO proceeds in funds managed by the cornerstone investor; and sharing of underwriting commissions.
Translation: Some of the cornerstone investors, including some tycoons and international funds, are no more than a lender of money and reputation to an issuer in order to fan up herd demand.
They don't suffer any loss. In fact, their appearance in a prospectus and pre-offering parties bring in returns as high as 40 per cent in six months, according to various industry sources.
So how is it done? After looking into three real cases, I shall show you the "cooking" in the form of a "semi-documentary". For obvious reasons, names and numbers are made up.
After two years of preparation, mainland developer George X was to launch the public offering of his residential projects in a month. The market was lukewarm, but he could wait no longer.
Beijing had tightened credit for developers, loan sharks were charging sky-high rates and George had a one billion yuan loan to repay in three months.
His sponsor approached some tycoons and international private equity funds for him. It's a name-list widely circulated in the market. George received two proposals.
Tycoon Y said he would subscribe for HK$100 million of new shares, but half of the money would come from George. George had to repay HK$50 million after the six-month lock up plus 30 per cent interest if the shares price did not grow to the agreed level.
A yield of 30-something per cent is only half of what Y has been charging as a loan shark. That is still good, because the IPO deal was a "bulk purchase" and he would get some of George's personal assets as collateral.
Fund house Z agreed to invest HK$100 million in return for a 20 per cent guarantee and a reinvestment of 70 per cent of the money in its funds. The fund would get not just the interest but a growth of HK$170 million in assets.
George went for Y because Y promised to bring in other billionaires on similar terms and to show up at the developer's IPO presentation. They would make headlines. George had to sell HK$200 million of shares in the IPO to pay the tycoons, though.
George was right. Pictures of the billionaires toasting him on stage were all over the financial media. The IPO was heavily oversubscribed.
The property house raised HK$2 billion. That is way below the official number. It did not matter to George, because the valuation of his company has been inflated anyway. The all-star list did not help much in its trading, though. The company never managed to trade above its offer price, and turnover has been weak.
That's fine. The property house subsequently raised HK$1 billion via high-yield bonds. That funding source would not have been available if it was not listed.
With the money, it survived the winter. As the economy went down and Beijing relaxed credit, George was alive and kicking again.
He was proud of his bold decision. The market has gone further down. Bankers have told him he would not be able to get a similar IPO deal without paying 40 per cent interest. Now that the exchange has officially barred the under-the-table arrangement, the price will only rise.
Wait a second. What about the repayment?
Well, six months after the public offering, a private equity fund manager got a call from a friend. The caller said George's company was happy to invest HK$100 million in his fund in order to diversify its risk and portfolio. There was a designated target of investment, though.
Guess what? Yes, it had to buy a stake in the developer from the tycoons.
For the service, the fund got a management fee and an asset growth. As its holding was below disclosure level, nobody knew.
This is not the end of it. Before the Lunar New Year, George was seen hunting for a good pledge of his controlling stake.
It will not come too cheap, though, because of the thin trading of his firm. A private banker told him the interest rate could go to 20 per cent. "That's fine. I can loan it out in the mainland at 100 per cent," said George.
Now you know who is the dumb one - the herd.