Asia has over 200 companies in the initial public offering registration pipeline – more than half of the deals expected worldwide. Companies and investors are waiting for markets to turn, finds Stefanie Eschenbacher.

China may have the largest number of state-owned enterprises in the world. And these enterprises have become an important source of initial public offerings (IPOs) in Hong Kong.

In fact, the past couple of years were the most prosperous for the Hang Seng Index, with Chinese companies accounting for as much as 83% of IPOs in one year.

Now that most of these enterprises have listed, what is next for the stock market in Hong Kong?

Justin Jacobson, index analyst at Renaissance Capital, says it has been a trying year for the Asian IPO market.

The Hong Kong Stock Exchange has seen its totals plummet as proceeds raised in Hong Kong have dropped by more than 70% year-on-year. Several deals were shelved – London-based Graff Diamonds, China Non Ferrous Mining Corporation and China Yongda Automobiles Services, for example.

Regarding performance, Jacobson says IPOs in Hong Kong have struggled more despite having a stronger overall equity market than China, but are now bouncing back.

The FTSE Renaissance Hong Kong/China Top IPO Index comprises the largest Hong Kong-listed companies, including Chinese Red Chips and H-Shares selected from the FTSE Renaissance Asia Pacific ex Japan IPO Index.

Although the FTSE Renaissance Hong Kong/China Top IPO Index is up 10.5%, measured year-on-year, it lags behind the Hang Seng Index, which is up 16.2%.

Jacobson says this is because of the index’s high proportion of Chinese IPOs. Both indices, however, are outperforming the Shanghai Shenzhen CSI 3000 Index, which lost 3% over the same time.

Ringo Choi, Asia Pacific strategic growth market leader at Ernst & Young, says companies and investors are skeptical. “They want to wait and see until the market recovers,” he says. “A large number of IPOs were completed last year, but these are trading significantly below their IPO price. This year, I have not seen the same size of companies coming to Hong Kong.”

Jacobson says Chinese growth concerns and increasingly stringent exchange-imposed regulations in Hong Kong have had negative effects on Asia’s IPO market this year.

“I have yet to see a concrete document of the changes. From what I gather, it looks as if the increased regulations apply to tightening the previously loose accounting regulations and auditing.”

He says the regulations first surfaced in July when Chinese fabric manufacturer Hontex, which went public in December 2009, was ordered to pay back all shareholders IPO proceeds after it was found to have used blatantly misleading information in its prospectus.

Ashley Alder, chief executive officer at the Securities and Futures Commission (SFC), then said in a statement that this was “an important milestone in the SFC’s efforts to protect the investing public from the consequences of wrongdoing”.

In the statement of agreed facts provided to the Court of First Instance, Hontex acknowledged that it had been “reckless in allowing materially false and misleading information to be included in its prospectus”.

The case was perceived as a milestone for the regulatory as it demonstrated its ability to take action against offshore companies and investors.

Deloitte quit as auditor of Daqing Dairy Holdings, a Chinese milk powder company, in March, just weeks after it had withdrawn from Boshiwa International Holdings, a children’s clothing manufacturer. KPMG, which declined to comment on the matter, left China Forestry, a Chinese timber company, in January.

‘STINKY FISH’
One year earlier, Deloitte was forced to exit as auditor of Longtop Financial Technologies, a Chinese technology company listed in the US. “Resignation in these circumstances is not a step we take lightly,” says a spokesperson.

“It is important to point out that our actions show the commitment of our audit professionals to applying appropriate professional skepticism and doing the right thing to trigger the disclosure of our concerns to shareholders and regulators.”

The spokesperson says the US court has ruled in favour of Deloitte China in the class action case of Longtop “affirming the role that Deloitte China played”.

That several high-profile cases appeared around the world in a such a short time raised concerns that some of the problems seen in Chinese companies that listed in the US will replicate in Hong Kong.

Muddy Waters Research estimates that the financial fraud committed by Chinese enterprises listed in the US amounted to $35 billion in the past five years. “Just as a stinky fish makes a pot of soup stinky, these fraudulent enterprises caused adverse effects among the China concept stocks in the US market and forced many a legitimate public company to suffer undue losses,” it says in a white paper, entitled Frauducation Part I: The Fraud School.

Choi says while the Hong Kong Stock Exchange is striving to be professional and international, with high and strict standards, it was the declining number of deals, rather than stricter policies in Hong Kong, that affected IPO activity. He also names the fiscal cliff in the US and the eurozone crisis as events that have generated uncertainty.

There are still more than 200 companies in the IPO registration pipeline in Asia, with the region accounting for more than half of the deals expected worldwide.

As Funds Global Asia went to press, American International Group was planning a listing worth up to $2 billion in what could be Hong Kong’s biggest IPO in two years.

Several other larger deals are expected to be completed by the end of this year, although it appears companies and investors are waiting for markets to turn.

“Companies look at price/ earings ratios in markets, at liquidity and how stocks have performed after IPOs when they decide on a listing,” he says.

Listing preferences vary from company to company and there is no clear trend whether Chinese companies prefer to list in Hong Kong or China.

Choi says some companies, such as property developers, face restrictions in China and will therefore be unable to pursue a listing in the domestic market.

COMPELLING
While A-shares tend to trade on higher price/earnings multiples, Hong Kong remains a compelling listing location.

“Sizable companies with an international focus will choose a larger market, such as Hong Kong, the United States, or even Singapore,” he says.

Although IPO activity in China and Hong Kong was down in the quarter, other Asian markets, such as Malaysia and Singapore, are active.

In its latest analysis of global IPO activity, Ernst & Young found companies in sectors such as mining, industrials and healthcare are pursuing IPOs.

Of the top ten global IPOs this quarter, six were listed on Asian stock exchanges. This includes Japan Airlines, which went public on the Tokyo Stock Exchange, Malaysia’s IHH Healthcare, which is dual listed on Singapore Stock Exchange and Bursa Malaysia, and China’s Inner Mongolia Yitai Coal on the Hong Kong Stock Exchange.

Overall, Asia accounted for 76% of global IPO proceeds raised in the third quarter of this year, with 102 deals raising $18.3 billion.

©2012 funds global asia