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On allocations and the perils of ECM club deals

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HONG KONG (Dow Jones Investment Banker) – Allocating distinct retail tranches within equity capital markets deals is a purely mechanical exercise that involves balloting by a share registrar and transfer agent. By contrast, assigning shares to institutional investors is more of an art than a science, and involves making subjective judgment calls. The recent US$2.5 billion equivalent placement by Ping An Insurance (Group) Company of China Ltd. shows how a seemingly simple transaction can leave a sour taste with investors, as well as the importance of structuring and allocating offerings in an even-handed manner.

On March 14, Ping An, the world’s second largest insurer, announced it was raising new equity to the tune of US$2.5 billion. The deal has proven controversial among market participants as a result of its design and execution, and because of disclosure issues that have subsequently emerged.

- Too big to fail? -

The capital raising, which was made at a substantial discount of 12.48% to market, was structured as a private placement with a single investor, a company owned by Hong Kong tycoon Cheng Yu-tung, who controls New World Group. The deal was – completely legally – conducted under a general mandate, without offering shares to other investors. Observers have pointed out that, since there appears to have been no pressing need for funding, such a large transaction would have been better undertaken, and as is more commonly the case, as a rights issue or, at the very least, as a wider placement involving a broad range of investors.

It then appeared, and was not disclosed by the issuer at the time, that M. Cheng had a sort position in Ping An shares in the form of cash-settled unlisted derivatives, representing some 72% of the proposed new issue of equity. Further, while M. Cheng had agreed to a six-month lock-up on his investment, the enforceability of that undertaking, conditional upon it being required by “applicable laws, legislation or regulatory rules” has been criticized by governance activist David M. Webb in Hong Kong, who pointed out at the time that, to his knowledge, no such requirements exist.

Although only representing 3.56% of Ping An’s existing shares – but a reasonably chunky 9.52% of its existing H shares in Hong Kong – the size of the deal was also very large, and out of line with M. Cheng’s normal investment size, going against a basic tenet when allocating an equity transaction.

This brings us back to institutional allocations.

While the Ping An deal could arguably be construed as a strategic, if somewhat messy, tie-up, allocating ECM deals more generally is no easy task.

In an IPO or placement, it involves scaling back orders to encourage aftermarket buying. Institutions will invariably complain that they receive very full allocations on difficult deals, and that they are not served well enough, or even in some cases “zeroed,” on blow-out transactions that are heavily oversubscribed.

While allocations are in theory the prerogative of issuers, the reality is that the process, which often takes all night, is in the hands of the banks’ equity syndicate desks, sometimes also involving senior salespeople. There is therefore always the risk that they may, on occasion, consciously favor those accounts that pay them substantial commissions through secondary market trading. Appointing more than one bookrunner or an independent adviser helps. The more banks involved, the more banks there are to keep each other honest.

Some shareholders, including sovereign wealth funds and government treasury departments are also known for being very hands-on when it comes to structuring and allocating ECM transactions.

In volatile markets, and at a time when many banks will be keen to push cozy club deals, issuers and their stakeholders may well find it to their advantage to be pushy – and to leave no stone unturned.

(Philippe Espinasse worked as an investment banker in the U.S., Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. Visit his website at http://www.ipo-book.com. Readers should be aware that Philippe may own securities related to companies he writes about, may act as a consultant to companies he mentions and may know individuals cited in his articles. To comment on this column, please email djinvesmentbankereditors@dowjones.com).

[This article was originally published on Dow Jones Investment Banker on 28 March 2011 and is reproduced with permission].

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