Formal pre-marketing begins today (Monday) for the bank's sole listing in Hong Kong, with 1.5 times price to book said to be the absolute line in the sand below which the bank is not prepared to drop.
Of the three joint global co-ordinators - Bank of China International (BOCI), Goldman Sachs and UBS Warburg, observers report Goldman has assigned the bank a fair value of 1.5 to 1.8 times book based on research published this weekend and UBSW, a higher 2 to 2.2 times level. Taking into account the valuations of the rest of the syndicate, the average valuation is said to have come out at 1.8 to 2 times and assuming an IPO discount, most expect the deal to price about 1.6 to 1.7 times.
Bank of China is said to have a book value of HK$55 billion ($7 billion) and is selling up to 25% of its equity through an all-secondary share offering. This means that at the bottom end of the range (1.5 times price to book) the bank will raise $2.65 billion and at the likely top end $3.18 billion (1.8 times price to book).
At these levels it will command a market capitalization of between $10.6 billion and $12.72 billion making it the seventh largest stock on the HKSE, sandwiched between Sun Hung Kai Properties and CNOOC. With a 3% to 3.5% weighting, it will also become the third largest bank behind HSBC Holdings, which has a 28.523% weighting and current market capitalization of $106.97 billion and its subsidiary Hang Seng Bank, which has a 5.46% weighting and current market cap of $20.5 billion.
However, as observers are keen to point out, it is extremely difficult to evaluate Bank of China in comparison to other Hong Kong banks since none provide a good match. The Territory's two other note issuing banks - HSBC and Standard Chartered - are both international heavyweights rather than domestic players, while Hang Seng Bank is so closely affiliated to HSBC that its figures and particularly return on equity (ROE) become skewed. Below Hang Seng, which has an asset base of HK$474.8 billion ($61 billion), there is also then a huge gap to the next listed comparable, Bank of East Asia, which has a much smaller asset base of HK$181.8 billion ($23 billion) and market capitalization of $2.96 billion.
As one banking expert comments, "Bank of China Hong Kong is a very unusual animal. It's a giant operator within a well-regulated and first world market economy. However, in virtually every single respect the bank itself has all the trappings, not to mention the management abilities and risk controls, of a third world bank."
Valuation models
The lead mangers are hoping that investors will be persuaded to look at the upside growth potential of an emerging markets play, with the downside protection of the HKMA's (Hong Kong Monetary Authorities) regulatory abilities. In assigning the bank a feasible valuation, they are said to have taken two approaches - one by plotting price to book against ROE and another using a discount dividend model.
Where the former is concerned, 2003 forecasts have been used by the syndicate since they are forward-looking, while the 2001/2002 figures are distorted by the up-front costs of consolidating one bank and 11 sister banks into a single entity, plus the provisioning associated with the carve-out of a significant proportion of NPLs.
Observers say that there is typically a close correlation between price to book and ROE and this is exemplified by the respective figures for Hang Seng Bank (P/B 3.5 and ROE 24%), HSBC (P/B 2.25 and ROE 14%) Standard Chartered (P/B 2 and ROE 12.5%), and Bank of East Asia (P/B1.2 and ROE 10%). Bank of China is said to be forecasting an ROE of about 11.5% for 2002 and 16% for 2004, figures that start to make its IPO price look more compelling.
In terms of the discount dividend model, Bank of China is well capitalized relative to BIS minimum ratios and reasonably well capitalized compared to its domestic peers, which have historically been over-capitalized because of difficulties finding new investment opportunities in Hong Kong's overcrowded banking sector.
Bank of China has told analysts that it intends to manage its tier 1 equity by maintaining a high dividend and estimates that it will be able to manage a pay out ratio of 60% to 70% of net income, while still sustaining ROE. Currently, the bank is said to have a total CAR of 14.5% of which tier 1 equity comprises 13.2%. By contrast Hang Seng Bank stands at 15.3% of which tier 1 is 12.3% and Bank of East Asia, 17.4%.
Whether the valuation is cheap enough divides market participants. Most agree that the swing factor will be the psychology of Hong Kong's retail investors. One argument has it that should the offering gather domestic momentum, the Territory's corporate investors will become involved and this in turn will convince global accounts that there is a sustainable foundation to an offering, towards which many are said to remain wary.
Flexible syndication
The syndication of the deal has consequently been kept as flexible as possible. In order to manage the deal effectively, the leads have successfully sought a waiver from the HKSE, which will allow the retail component to be increased beyond 10% of the overall offering without needing the usual 15 times oversubscription level to trigger claw backs from the international tranche.
All retail investors may also be incentivized either through a discount in pricing to the international tranche, or through the award of bonus shares. Nothing has yet been finalized and although the most recent example came from the MTR Corp in September 2000, Bank of China is unlikely to be as generous since it is not a pure Hong Kong privatization. MTR, for example, priced the retail tranche of its IPO at a 5.25% discount to the international and gave retail investors one bonus share for every 20 held at the end of the first year and a further share for every 15 held at the end of the second year.
To encourage wide scale distribution, a public offering (POWL) without listing in Japan has also recently been incorporated. Typically this would amount to about 10% of the total, although again there is no pre-set cap.
Nomura will be the joint lead manager for the POWL and is also one of five co-leads on the international tranche alongside Deutsche Bank, Merrill Lynch, Morgan Stanley and Salomon Smith Barney. There are also eight co-managers comprising ABN AMRO, Cazenove, Daiwa, Fox Pitt Kelton, ING Barings, JPMorgan, Lehman Brothers and SG Securities.
Following the completion of pre-marketing, roadshows are scheduled to begin on July 8, with the deal scheduled to price on July 22 and list on July 25. In selling the transaction, the leads are likely to be faced with a barrage of questions on a whole series of negative issues concerning fraud, inadequate risk management and growth potential in a saturated domestic market where new loan growth is low and net interest margins are under pressure.
Negative commentary - fraud and NPLs
In the run-up to the deal, commentary has also almost exclusively concentrated on the first two issues. In January, for example, a $20 million fine for irregularities at the bank's New York branch led to the cancellation of a US listing and was followed in March by a disclosure that $483 million had been stolen from the bank's Kaiping branch in Guangdong province.
Where inadequate risk management is concerned, there has been rampant speculation about the true level of the bank's NPLs and how it intends to deal with them. In terms of the latter, it has variously been rumoured that the bank would either transfer NPLs back to its parent or at one point that it was intending to create a Cayman's Island SPV, under Hong Kong's true sale ABS laws, which would enable the transfer of NPLs off balance sheet.
Selling points - cost cutting, cross selling and PRC growth
Lead managers are likely to be hoping that now the bank is in a position to promote its story for the first time publicly, the emphasis will change to the synergies inherent in its recent consolidation as well as the cost cutting measures that will enhance profitability and the potential for revenue growth from its branch network on the Mainland.
Branch numbers make the potential cost savings from consolidation very clear. Bank of China currently has 340 branches in Hong Kong and the IPO vehicle incorporates one branch in Macau and 13 on the Mainland. By contrast, HSBC has 169 branches in Hong Kong, while Hang Seng Bank has 150 and Bank of East 130 in Hong Kong and 16 on the Mainland. To date, the only closures Bank of China has made have been when two sister banks were operating branches on the same street.
And with a 3.7 million bank accounts and an estimated customer base of 3.2 million (some customers hold more than one account), the potential for cross-selling across the whole bank is equally clear. Analysts comment that the one overriding trend of the Hong Kong banking market is the bias towards larger banks, which can capture market share by providing one-stop-shopping for financial services. Since the initial investment this requires is so costly in terms of IT systems and branding, it is consequently harder for smaller banks to recoup some of the costs by gaining economies of scale and as a result many are becoming increasingly marginalised.
For Bank of China, the process of leveraging of its new platform has only just begun since the consolidation of the 12 banks and two subsidiaries was finalised just last October. Outside of Hong Kong, the growth potential of the Mainland is also likely to be emphasized as China opens up RMB banking in advance of WTO and Bank of China expands its Mainland branch network - currently clustered in the coastal provinces and previously confined to facilitating cross border trade for its Hong Kong clients.
The bank is also likely to emphasise that new and centralised risk management systems will systematically reduce NPLs that stand far higher than the Hong Kong average. The IPO prospectus will show a post carve-out ratio of 9.5% following the transfer of HK$11.4 billion ($1.47 billion) NPLs at book value to an AMC under the Beijing-based parent. Without the carve-out the bank would have found it very hard to market the offering, since the Hong Kong banking sector averaged 5.03% at the end of the first quarter, while-better rated banks such as Hang Seng and Bank of East Asia both reported 3.1% levels during 2001.
Bank of China has said that it hopes to get the figure down to 8.4% at the end of 2002 and intends to set aside HK$2.2 billion in provisioning. Its efforts have won some fans. Moody's banking analyst Wei Yen says, "There has been a tremendous amount of change over the last eight to nine months and the bank has made a huge investment in risk management systems. Management is trying very hard and I think we will definitely see some improvement in the quality of loans going forward."
Observers also emphasise that auditors PricewaterhouseCoopers have gone through the existing loan book with a fine toothcomb. Any loan greater than HK$20 million that is either China-related or recently restructured has been examined, as has the entire loan portfolio for the bank's top 100 non blue chip borrowers.
Bank of China is expected to release its 2001 profit figures in the middle of this week and observers conclude that it is likely to report net profit figures around the HK$2.77 billion mark ($356 million), down nearly 50% from a year earlier and some way below Hang Seng Bank, which reported HK$10.1 billion for the same period.
The figures have been emasculated by consolidation costs and NPL provisioning and observers say that pre-provisioning, the results will show a revenue split of 41% retail, 33% corporate banking and 29% Treasury.
For fund managers, buying Bank of China will be necessitated in the long-term by its MSCI weighting. However, since there is a 24 month discretionary period before it is included, some may conclude that it will be safer to watch its short-term secondary market performance before making a full investment decision. Year-to-date, the Hang Seng Index is down 7.066%, although banking stocks have generally outperformed, with HSBC down 3.29%, Hang Seng down 2.62% and Bank of East Asia down 4.76%.
