HONG KONG (Dow Jones Investment Banker) – Forget the theory about pre-deal investor education (PDIE) and the price discovery process. In these volatile markets what really matters is to initiate book building only when a deal has effectively already been covered. Here’s why – and how.
ECM bankers have for years relied on research analysts and salespeople to prepare the ground by conveying the basics of the investment story, with a view to setting up a marketing price range. This is then followed by a roughly two-week demand-gathering process at the end of which the final offer price is determined, based on the book of demand. In theory, as the book is built, messages are communicated to investors so they can increase their price limits to secure their allocations, in what increasingly becomes an over-subscribed transaction.
But in today’s brave new world the old recipes no longer work. In Asia, for an IPO to price at all, today the book must already be pretty much covered before (or as) book building formally starts, block trade-style – a quest that begins early in the execution process.
At an advanced stage, selected investors get an “early look” at the company through an informal meeting with management, during which they become acquainted with the business, and start work on the equity story. These accounts are generally drawn up from a who’s who of major market players, including large asset managers, tier-one hedge funds, tycoons or even corporates that are could be keen to secure a strategic stake.
Closer to launch, these accounts will sign confidentiality agreements, receive a draft copy of the preliminary offering circular and be provided with further access to management for due diligence, before committing to a disclosed “cornerstone” stake, with a guaranteed allocation at the offer price – not at a discount – and generally against a commitment to lock up their stakes for a period of six months.
[Click HERE for my DJIB column “LANDSCAPE: Cornerstone investments and ethics” – 20 December 2010]
On top of these, other high-quality anchor investors, whose demand is neither disclosed nor locked up, are also identified. This is in order that the bookrunners can confidently launch a deal, safe in the knowledge that good momentum will follow. Today, investors no longer want to commit to offerings that might struggle to price – and are therefore likely tumble in the aftermarket. Sending management on a global roadshow to support a deal that’s for all intents and purposes already done is the best way to ensure a successful outcome.
A quick look at some notable transactions in Hong Kong over the last quarter shows the strategy appears to be working, even though post-deal price performance remains an issue for now.
Last fall, CITIC Securities Co. Ltd. secured US$850 million of demand from six institutions for its US$1.8 billion IPO, also announcing that the deal had already been fully covered even before the start of the roadshow. And New China Life Insurance Co. Ltd. also raised US$780 million in cornerstone orders prior to launching its US$1.3 billion H share IPO earlier this month, communicating at the end of the first day of book building that the institutional tranche had already been raised in full.
Conversely, Chow Tai Fook Jewellery Group Ltd.’s offering, also this December struggled, as it failed to secure cornerstone accounts. While the book was said to have been covered at an early stage, the company slashed the offer size by a third from an expected US$3 billion to US$4 billion, pricing the deal at only 15 times its 2013 earnings, far lower than the 25x it had initially looked to achieve. That hinted at low overall quality demand. And Haitong Securities Co. Ltd, which only managed to canvass US$222 million in early interest prior to the recent launch of its US$1.7 billion IPO, ultimately ended up pulling the deal altogether.
[Click HERE for my South China Morning Post column “Mainland jewellery favourite set to sparkle in the gloom” – 21 November 2011]
[Click HERE for my DJIB column “TIER ONE: Haitong Securities tries to steal the limelight” – 5 December 2011]
The IPO model is not broken yet. But key in today’s environment is redefining offer structures and maximizing momentum in what has become a volatile and often unpredictable primary equity market.
(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 https://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 [email protected]).
[This article was originally published on Dow Jones Investment Banker on 28 December 2011 and is reproduced with permission.]
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