South China Morning Post opinion article

, , China, Cornerstones, Hong Kong

The market rout and volatility in Asia, and around the world, is likely to lead to an increasing number of cornerstone tranches in IPOs. Very much a feature of new listings in Hong Kong and, to a lesser extent, Singapore, cornerstone investors are large institutions that commit in advance to buying a fixed, pre-agreed allocation in a transaction.

Unlike pre-IPO investors, who in Hong Kong now usually need to invest at least six months ahead of the start of trading, cornerstones feature late in the process. This is generally around the time of investor education, just before the management roadshow and as shares are about to be offered through bookbuilding.

And unlike pre-IPO investors, they do not benefit from a discount. They pay the offer price, like any other investor, although how many shares they ultimately receive is decided upfront in exchange for their early commitment.

The catch (in Hong Kong at least) is that they also commit, through a lock-up, not to sell their investment – so as not to depress the share price after the IPO – usually for a period of at least six months.

Sovereign wealth funds, such as Singapore’s Temasek, China’s CIC or Malaysia’s Khazanah Nasional, are often invited into deals as cornerstones. So, too, are a number of large funds from the Middle East, such as Abu Dhabi’s ADIA or Kuwait’s KIA, and some of the larger hedge funds. And, of course, well-known tycoons, such as Li Ka-shing (and companies controlled by him, such as Cheung Kong Holdings) or Chow Tai Fook’s Cheng Yu-tung, Henderson Land’s Lee Shau-kee or Wharf’s Peter Woo Kwong-ching, are no strangers to the practice.

For investment banks, cornerstone tranches are a godsend. They enable the bookrunners to launch a transaction safe in the knowledge that anywhere from 20 per cent to 50 per cent of the offering is already de facto pre-placed, making it easier to gather demand for the rest of the deal, especially in challenging market conditions such as the ones we are experiencing.

Given the high profile of participating institutions, cornerstone tranches can also provide a measure of comfort to less experienced investors, who often do not have time to analyse the prospectus in detail, nor the ability to conduct an in-depth review of the investment story.

As for the cornerstone investors themselves, they can secure a significant position in a stock, which may otherwise require significant time and effort to achieve through secondary market purchases. And because IPOs are often priced at a discount to the trading levels of comparable companies, on average, such commitments yield handsome rewards.

However, there have been recent examples where such a bet has proven a bit of a sting. The 12 investors in Glencore’s US$10 billion IPO, which collectively chipped in last May for a total of US$3.1 billion in one of the largest ever cornerstone tranches in a flotation, were, at the time of writing, sitting on a loss of almost 30 per cent in Hong Kong. And the 13 institutions that committed in advance some US$415 million to the IPO of Huaneng Renewables in June were also facing a drop in value of more than 21 per cent.

For brokers, cornerstone tranches often provide an additional source of business down the line through block trades, as some of these investors attempt to book significant capital gains after their lock-up has expired.

The flip side, of course, is that prices often come under pressure around that time, as the market anticipates sell-downs that might arise from such a large “overhang” of shares.

No pain, no gain.

Philippe Espinasse worked as an investment banker in the US, Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. He is the author of IPO: A Global Guide, published by HKU Press.

[This article was originally published in The South China Morning Post on 29 August 2011 and is reproduced with permission]

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