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Tom Holland

With Hong Kong's stock market gearing up for a bumper year of initial public offerings, investors should take care: buying into IPOs may not be as rewarding as they believe.
According to accountants PricewaterhouseCoopers, some 60 companies are likely to list their shares in Hong Kong this year, raising over HK$300 billion.
If the bean counters are right, 2010 will  be second only to 2006 in terms of money raised. 
No doubt many of the investors who buy into the spate of IPOs  will intend to be long term owners. 
But a  sizeable proportion will be hoping to make a quick killing. In fine Hong Kong-style, these opportunists will flip their allocations of shares straight back to the market in the hope of picking up spectacular first day trading gains that on some occasions in the past have exceeded 100 per cent.
Those investors might like to take a look at a research paper published last month by Joseph Fung and Sanry Che of Hong Kong Baptist University. 
Working with data for 386 Hong Kong IPOs between 2000 and 2007, they show that the returns investors actually made were often considerably less than the first day performance of newly-listed shares indicated.
The reason for this discrepancy is the IPO mechanism itself. In Hong Kong would-be participants in public offers must pay for all the shares they subscribe for in advance.
The trouble is that Hong Kong IPOs are often massively over-subscribed. According to Fung and Che, between 2000 and 2007 Hong Kong IPOs raised HK$1.1 trillion, but attracted almost HK$12 trillion in subscription cheques.
The issuing companies get to bank these cheques, only returning the excess funds - without interest - to unsuccessful subscribers once the allocation process is complete, often a couple of weeks later.
That's good news for issuers. As the first chart below shows, on average between 2000 and 2007 the interest income they pocketed from subscribers' cheques amounted to 1.6 per cent of the IPO funds raised from public subscribers (assuming interest was earned at the Hong Kong interbank offered rate). To put it another way, the interest that issuers earned on subscribers' funds amounted to a hefty 6.3 per cent of their forecast profits for the year, or 10.8 per cent for red chips.
But what benefits issuers is less advantageous for investors. Even successful investors typically receive only a fraction of the shares they subscribe for, which means the bulk of their money is tied up for a couple of weeks at zero return.
As a result, subscribing to an IPO involves an opportunity cost. If subscribers have withdrawn funds from their bank, they miss out on interest payments at the deposit rate (which, to be fair, is not much right now). If they have borrowed the subscription money, their cost will typically be borne at the prime rate.
If we take  add in transaction fees, the IPO returns actually earned by investors drop considerably.
As the second chart below shows, for investors subscribing to H-share issues with borrowed money between 2000 and 2007 the median first day return dropped from a headline 12.55 per cent to just 5.77 per cent. If issues are then weighted according to size, the return on red-chip offerings actually turns negative.
Of course, with interest rates low at the moment many investors will shrug off these considerations and subscribe anyway. But it's still worth bearing in mind that for many first day stock flippers, buying into IPOs is not quite the lucrative trade it may seem.




Flipping IPOs is not as rewarding as you think