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'Orient can raise more money in Hong Kong than it could through a mainland IPO' |
On April 11, a draft prospectus appeared on the Hong Kong Exchanges and Clearing website for a company called DFZQ. The 568-page Application Proof, as draft prospectuses are known on HKEx, is heavily redacted on timetable and amount, but illuminating all the same: DFZQ is better known in English as Orient Securities, the Chinese capital markets house, and it is thought to be seeking as much as $1 billion.
The proposed deal catches the eye for several reasons. The first is that Orient is Citi’s securities joint venture partner: it holds 66.67% of Citi Orient, and Citi 33%. Citi Orient is one of the handful of JVs, alongside UBS Securities, Goldman Sachs Gao Hua and Zhong De Securities (which partners Deutsche Bank and Shanxi Securities), that is doing well both in terms of deal volume and profitability. According to data from the Securities Association of China, as of June 30 2015, Citi Orient ranked second among foreign JVs for net profit (albeit only Rmb162.8 million ($25.1 million) – there’s still not a huge amount of money to be made in these ventures), second for total revenue, third for underwriting fees and ranked top for financial advisory fees and second for M&A fees.i
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** Daiwa SSC and Fortune CLSA are no longer foreign JVs. Each has been acquired by a Chinese securities firm. |
A Citi official says the Orient Securities IPO will make no difference to the JV, since it’s a listing of the parent in isolation, and JVs aren’t allowed to engage in business that conflicts with the parent. Nevertheless, it will be interesting to see if the once-removed presence of Citi and the relative success of the JV prove useful in marketing the parent’s listing.
The second reason the deal is interesting is the selection of Hong Kong rather than China as a listing venue. Orient is already listed in Shanghai, but could have opted to raise more capital domestically, particularly in this low-valuation environment. Some commentators have said the choice of Hong Kong is because of the suspension of capital raising in mainland China, but in fact that suspension was lifted in December and only applied to IPOs. Instead, the answer must be more pragmatic.
“Orient can raise more money in Hong Kong than it could through a mainland IPO, and it will possibly be an easier process for them,” says Stephen Baron, an analyst at Z-Ben Advisors, the Shanghai-based research group.
Wherever it raises capital, it faces very obvious headwinds. The A-share (domestic mainland Chinese) market has been more volatile than the H-share (Chinese companies listed in Hong Kong) market, but that hardly makes H-shares a haven of peace, particularly when it comes to the listing of mainland securities companies.
Shares in Guolian Securities, which listed in Hong Kong in June 2015, trade at less than half their level at launch. Hengtai Securities followed in October and is also well down on its listing price.
'Time is right'
Although many Chinese securities firms are believed to be ready to launch in Hong Kong when the time is right, among them China Merchants Securities and Everbright Securities, Orient appears to be the first since the Chinese market crash to believe that now is the time.
That said, the draft prospectus is careful to give no indication of timing, though it is understood that the joint sponsors – Citi, Goldman Sachs and Nomura – are sounding out the possibility of a listing within the next few months.
When they do decide to go ahead, it will be interesting to see how different the numbers in the final prospectus are from those in the draft.
The draft – which uses numbers from December 31 2015 – shows fabulous performance: a 72% increase in revenue from 2013 to 2014, then a 159.4% increase from 2014 to 2015, reaching Rmb20.46 billion.
The problem is, assuming the interim results are out before the company lists, the next numbers are likely to look rather different.
As Orient itself says in the draft prospectus, the increased income reflects “an increase in income from our wealth management business as a result of increased trading activity of the A-share market, the overall strong performance of our asset management schemes in our investment management business” leading to an increase in performance fees, and “an increase in our net investment gains from our fixed income as well as equity securities investments.”
One would imagine all of those sources of income have taken a bit of a dent, particularly anything proprietary related to A-shares. China’s CSI300 dropped 21% in the first month of the year alone, and, despite a subsequent rebound, was still off 13.8% in the first quarter. Orient says: “Our revenue was materially and adversely affected.” How much so will have quite an impact on how attractive the IPO looks, particularly to retail investors who tend to make decisions on headlines.
Baron, though, says the numbers may not look too bad. “Profits in the brokerage industry have continued to increase,” he says. “Yes, a fair portion of the revenues for the larger companies were derived from proprietary trading, but they continue to appear healthy.”
Clamp down
A bigger issue, in his view, is the drastic shrinkage in margin lending volumes as the A-share market collapsed and regulators tried to clamp down on individual leverage. He says the outstanding margin trading balance has fallen from a peak of Rmb2.4 trillion to about Rmb800 billion this year. Margin lending, he says, is “a nice earner” for Chinese securities houses; the earnings that come from it will be missed.
Either way, this would all have been a much easier sell last June.
Still, cash is always welcome, now in particular.
“The IPO process may benefit their [Orient’s] securities operations on the mainland,” says Baron. “It will give them more cash to bolster the margin trading and stock lending side of the business and invest into other areas. We’ve seen it before with Citic and Haitong: use the IPO to reinvest in the company and create strong brand names in the industry locally and to make international acquisitions.”
Next, another member of the same group may come up with a still more important transaction. Orient is the largest (39.96%) shareholder in China Universal, a fund management business with Rmb107.9 billion under management, one of the top 10 in the industry in both asset and performance terms. Baron reckons it, too, is planning to list, and may well become the first Chinese mutual fund company to do so.
That would be a landmark. Perhaps we’re not too far from the day when a Sino-foreign securities JV lists in its own right.
