The launch of investor education for China Cinda Asset Management earlier this week has put renewed focus on China’s financial sector.
And the upcoming IPO, which sources say could raise between $2 billion and $3 billion, is attracting a lot of attention among international investors not just because it looks likely to be one of the last, if not the last, multi-billion dollar listings in Hong Kong this year.
Sure, the city has just seen two mainland banks – Bank of Chongqing and Huishang Bank – list after raising $548 million and $1.19 billion respectively, but both those deals were heavily placed with China-based corporate investors and high-net-worth individuals. International investors were less keen.
One key reason for the lack of offshore demand was the fact that regulatory requirements forced the banks to price their IPOs quite aggressively. But in addition to that, many international investors also felt that the two city commercial banks didn’t offer much differentiation versus the nine mainland lenders that were already listed in Hong Kong.
According to one financial sector banker, foreign investors already own about $1 trillion worth of Chinese bank stocks and, given the fundamental concerns about the industry, there isn’t a lot of appetite to add to that – unless they can do it on the cheap.
Cinda is a different story. As the first of China’s four distressed asset management companies (AMCs) to go public, it is offering a unique exposure to a part of the country’s financial industry that is viewed to have strong growth prospects and that has so far been out of reach for stock market investors.
And that is a tempting prospect for even the most discerning investor -- even if the company is not immune to a slowown in growth and a decline in asset prices, and despite some commentators questioning the effectiveness of its asset disposals and its route to profitability.
Bankers involved in the Cinda IPO confirm that there is a lot of initial interest from global funds, but given that it is a “new” industry that has so far not been particularly transparent, investors will need time to understand the company’s business model and to make sense of its financials.
As a result, the bookrunners will spend two full weeks pre-marketing the transaction and gathering feedback from investors with regard to valuation before the management takes to the road on November 25 to provide further insight about the business. The pricing is tentatively scheduled for December 3 or 4, allowing the stock to start trading the following week.
The final structure of the deal will not be determined until closer to the start of the roadshow (and the opening of the institutional order books on the same day). As for now, sources say the deal will account for between 10% and 20% of the enlarged share capital with the final size depending on the valuation. Most likely, the number will end up between 10% and 15%, but the richer the valuation, the more the issuer is likely to sell, they say.
A portion of the deal will likely be taken up by cornerstone investors, but discussions are ongoing and since the leading banks are still dealing with the issuer on an individual basis rather than as a coordinated group there is no real overview of the process at this point.
The one thing that is clear, is that the deal will consist of all new shares – and that it is set to become the largest IPO in Hong Kong this year ahead of Sinopec Engineering’s $1.8 billion offering in May and the more recent $1.3 billion deal by China Huishan Dairy in September. That in itself will help to draw attention to the transaction, which is coming to market at a busy time for Hong Kong IPOs with several issuers aiming to grab the last window to go public before the end of the year.
Cinda and the other three distressed asset management companies were all set up in 1999 to acquire and manage a huge amount of non-performing loans (NPLs) from the country’s largest state-owned banks as they prepared for a stock market listing. The loans were all bought at face value and the funding was obtained from a combination of loans from the Peoples Bank of China and the sale of domestic bonds.
The first batch of assets acquired by Cinda was made up of Rmb250 billion (about $40 billion at today’s exchange rate) of NPLs from China Construction Bank (CCB) and Rmb100 billion of NPLs from China Development Bank. The following year it took on another Rmb23 billion of doubtful debts from CCB.
Since then, the role of the distressed asset management industry has widened significantly to include the acquisition and restructuring of distressed debt from state-owned enterprises outside the banking sector and the four AMCs are now also allowed to buy loans at a discount to face value – typically at 25 to 30 cents to the dollar – which makes it a lot easier to achieve a profit.
Cinda has also moved into other financial services, such as brokerage, investment banking, principal investments, trust services, financial leasing and insurance and in 2012 it raised new capital through the sale of equity to four strategic investors, including UBS and Standard Chartered Bank. On the back of that, the Ministry of Finance’s ownership fell to about 83.5% from 100%, while China’s National Social Security Fund bought about 8%, UBS 5%, Citic Capital 2% and Standard Chartered approximately 1.5%.
As of the end of June, Cinda had $284 billion of total assets, which makes it the largest among the four AMCs and, according analysts, puts it on par with China’s large-sized city commercial banks. About 56% of the total asset value comes from distressed assets and the management of such assets contributed just over 70% of the Rmb5.1 billion pre-tax profit in the first half of this year, according to a syndicate research report.
Analysts also attribute just over 80% of Cinda’s estimated fair value to the distressed asset management business, suggesting that this will remain the key driver of the business for the foreseeable future, especially since the amount of NPLs in the Chinese banking system is expected to increase sharply following five years of massive credit injections. The earlier mentioned syndicate research report project that the amount of NPLs will double in absolute value by 2015 while their proportion of total loans will increase to 2.5% from 1.6% in the first half of this year.
With a 35% market share of NPLs acquired by the four AMCs since 1999, Cinda is expected to be a key beneficiary of that trend. Or as one banker put it: “Cinda is the only [listed] company that can benefit directly from a clean-up of the Chinese banking system and it has an immense scope to grow.”
At the same time, corporate profitability is coming under pressure as the economy is slowing, creating more opportunities for Cinda to acquire receivables owed by companies facing cash-flow difficulties.
The business is not without risk though. While some observers continue to refer to Cinda as a counter-cyclical business thanks to its ability to benefit from an increase in NPLs, a slow-down in macro-economic growth will have a negative impact on the value of the assets in its existing portfolio and the return on those assets.
The uncertainty about the timing of the distressed asset disposal and the exit of the equity it holds in hundreds of listed and unlisted SOEs as a result of debt-to-equity swaps is also a concern since it means the company may face a lot of earnings volatility, one report notes. On top of that, Cinda also has a heavy exposure to China’s real estate and coal sectors.
Cinda is also more vulnerable to a liquidity crunch than the banks since a large part of its funding comes from the wholesale interbank market, according to the same report.
So far, the company has demonstrated an ability to generate attractive returns on its distressed assets, however. According to syndicate research reports, it has achieved an internal rate of return of 18% to 20% on its NPL portfolio, excluding the initial loans that were bought at face value, while the restructuring of distressed debts from non-financial sector enterprises is generating yields of 12% to 13%, resulting in a return-on-assets of more than 4%.
By the end of 2012, the company had acquired a total of Rmb1.1 trillion of NPLs and recovered Rmb277 billion of cash from the sale of distressed assets.
The fair value attached to Cinda varies quite significantly among the syndicate banks, but in general ranges from 1.2 to 1.7 times its 2013 post-money book value.
Its combined holdings of debt-to-equity swap (DES) assets were valued at Rmb43.6 billion at the end of June, according to two research reports. About 79% of that is made up of unlisted shares. Based on the valuations achieved on similar assets so far, analysts expect Cinda will be able to sell these unlisted assets at two times the book value.
Bank of America Merrill Lynch, Credit Suisse, Goldman Sachs and Morgan Stanley are joint sponsors for the transaction and the general belief is that they will be mandated joint global coordinators as well – a role that is also expected to be given to UBS, sources say.
There is talk about an additional five to 10 bookrunners, bringing the total number of banks working on the deal to between 10 and 15, although the final line-up has yet to be confirmed by the issuer. The bookrunners are expected to include mostly domestic Chinese banks from which Cinda is buying its NPLs. Standard Chartered is also said to be given a role in its capacity as a shareholder.
