Chow Tai Fook Jewellery raises $2 billion from IPO

Chow Tai Fook Jewellery Group on Friday priced its Hong Kong initial public offering at the bottom of the range at HK$15 per share. Demand was sufficient to cover the base deal and the 15% greenshoe, but not enough to exercise the 20% upsize option, leaving the deal size at HK$15.75 billion ($2 billion).

Still, this makes it the third-largest IPO in Hong Kong this year, excluding Glencore International, which listed more than 90% of its $10 billion IPO in London. If the shoe is exercised in full, Chow Tai Fook Jewellery’s offering could rise to $2.3 billion, pushing it into the top two after Prada’s $2.5 billion IPO and ahead of Shanghai Pharmaceutical’s $2.1 billion deal.

According to sources, some investors who had earlier indicated an interest in the deal were reported to be uncomfortable to take on additional risk as markets fell ahead of the European Union meetings on the debt crisis and never submitted their orders. Their concerns were likely exacerbated by the fact that Chow Tai Fook doesn’t start trading until December 15, leaving little time to recover any potential losses if it was to come under pressure in the first few days — something that could happen if the overall market remains negative until then.

In an indication of the tough market environment — and the intense competition for capital as numerous IPOs are trying to get done before year-end — Haitong Securities deferred the pricing of its H-share IPO from Friday until today. The delay suggests that the company is trying to find some last minute demand to cover the $1.5 billion to $1.7 billion deal. If it fails to do so, the IPO could be pulled.

The latest market signs are positive, however, with stocks in Europe and the US recovering on Friday after 26 of the 27 countries in the European Union agreed on a new treaty that will move the EU towards fiscal union. Among other things, the new treaty will enforce stricter budget discipline in an attempt to save the euro. Britain declined to participate in the plan for deeper economic integration, however, and it is expected that several other governments may find it difficult to get the treaty approved in their home countries. For now though, markets are breathing a sigh of relief. The German DAX index rose 1.9%, the French CAC 40 jumped 2.5% and even the FTSE 100 added 0.8%. In the US, the Dow Jones index gained 1.6% and the Nasdaq Composite rose 1.9%.

And even though some investors got cold feet, at a valuation of 15 times forward earnings Chow Tai Fook Jewellery’s IPO worked for enough investors. The expectation that the stock will go into a number of key indices, including Hong Kong’s benchmark Hang Seng Index, also added to the attraction. While index funds typically don’t buy the shares until shortly before closing on the day before they are included, funds that benchmark against the same indices may have taken the opportunity to buy in the IPO.

FTSE announced early last week that Chow Tai Fook Jewellery will be fast-tracked into its Hong Kong Index and its Hong Kong Index ex-H Shares from December 19, two trading days after its debut.

About 180 institutional investors took part in the deal, one source said. The numbers were slightly skewed towards hedge funds, but in terms of order value, the majority came from long-only funds. The top-five allocations all went to big long-only names, the source noted. The demand was price sensitive and hedge funds submitted smaller-than-usual orders for an IPO of this size. About 25% of the offering went to corporates and private banking investors.

The retail tranche, which accounted for 5% of the deal, was six times covered, which was a welcome change from several other recent IPOs in Hong Kong, including New China Life Insurance’s $1.9 billion A- and H-share IPO, which priced the day before Chow Tai Fook Jewellery. The insurer had set aside 5% of its $1.3 billion H-share offering for Hong Kong retail investors, but got enough demand to cover only 60% of that.

Investors were attracted by Chow Tai Fook Jewellery’s well-known brand name and its strong and growing market position in China. The company, which is controlled by Hong Kong tycoon and New World Development chairman Cheng Yu Tung, was established more than 80 years ago and is the largest jewellery retailer in Hong Kong and China in terms of market share. It specialises in gold and diamonds and focuses on the so called mass-luxury market. It has more than 1,500 retail outlets spread across China, Hong Kong, Macau, Taiwan, Malaysia and Singapore and also owns diamond-cutting facilities and jewellery design and manufacturing plants. The latter produce more than 7 million pieces of jewellery every year.

The company has a target to open about 200 stores per year, which translates into about 18% growth in 2012 and is slightly above the 179 stores that it has, on average, opened in each of the past three years. About 90% of the new stores will be located in mainland China.

Aside from the sell-off in the secondary markets towards the end, the market backdrop was actually positive during most of Chow Tai Fook’s two-week roadshow, which may have prompted some investors at least to go ahead and subscribe. The Hang Seng Index gained 8% and among its smaller Hong Kong-listed competitors, Luk Fook was up 16.2%, while Chow Sang Sang added 2.7%.

Chow Tai Fook sold 10.5% of its share capital in the form of 1.05 billion new shares. The shares were offered at a price between HK$15 and HK$21 apiece, which translated into 15 to 21 times its projected earnings for the fiscal year to March 2013. As mentioned, the price was fixed at the bottom of the range.

Even so, it still comes at a premium versus Luk Fook and Chow Sang Sang, which trade at forward price-to-earnings multiples of 10.3 and 9.5 respectively. Luk Fook has the same March year-end as Chow Tai Fook, while Chow Sang Sang’s price-to-earnings multiple refers to calendar 2012.

Chow Tai Fook is significantly bigger than Luk Fook and Chow Sang Sang in terms of market cap and has close to twice the number of points of sales as the former and more than four times as many as Chow Sang Sang. However, coming from a smaller base the latter two are growing at a faster pace.

Looking at international brands, Tiffany trades at a 2012 price-to-earnings multiple of about 16 times, and Prada, which became the first luxury consumer brand to list in Hong Kong earlier this year, is trading at a January 2013 multiple of about 17 times.

Deutsche Bank, Goldman Sachs, HSBC and J.P. Morgan were global coordinators for the offering, while Citi, Credit Suisse and UBS joined them as joint bookrunners.

Haitong Securities’ H-share IPO is arranged by Citi, Credit Suisse, Deutsche Bank, Haitong International and J.P. Morgan as joint global coordinators. The same five banks are also acting as joint bookrunners together with HSBC, Nomura, Standard Chartered and UBS.