China’s investment bank

You’ve got to call this a hot new issue,” an analyst told the New York Times. The flotation under discussion was that of Morgan Stanley and the date was March 22 1986.

The 51-year old firm was one of the last of the American bulge bracket investment banks to list on the New York Stock Exchange, but its $293 million flotation provided investors with immediate upside. Shares rose 26% on their first day of trading, meaning Morgan Stanley ended the day with a market value of $1.5 billion (it has since risen to $63 billion, notwithstanding the odd seismic bump along the way).

Today sees the pricing of an IPO involving its Chinese cousin, China International Capital Corporation (CICC). Has the company – which was set up in 1995 as the first Sino-foreign joint venture investment bank – lived up to its billing as China’s answer to Morgan Stanley? Will it provide prospective IPO investors with the same share price growth as the US investment bank did before it?

In the early days of the JV, partners China Construction Bank and Morgan Stanley both had very high hopes. The former hoped to leverage Morgan Stanley’s expertise to create a homegrown investment bank with a global reach. The latter, meanwhile, paid $37 million for a 34.3% stake and access to a Chinese IPO pipeline that might prove every bit as lucrative in the 21st century as America’s had been in the 20th century.

Within six years, however, these conflicting ambitions led Morgan Stanley to cede management control to the Chinese. The American bank quit completely in 2010 when it sold its stake for $700 million to a group of investors including private equity firms KKR and TPG, as well as Singapore’s sovereign wealth fund, GIC.

Morgan Stanley could at least console itself with a roughly twenty-fold increase on its original investment. In comparison, the likes of KKR and GIC are currently sitting on a 28% to 44% gain based on CICC’s $2.62 billion to $2.95 billion IPO valuation.

One man has been the face of CICC: Levin Zhu, the son of Zhu Rongji, the former Chinese premier who pushed forward the country’s privatisation programme during his decade in high office through to 2003. Caixin Weekly describes Zhu junior as an “idealist” on a “historic mission” to create a world beating investment bank.

During its first decade of existence CICC seemed to be well on its way to success. It captured nearly all the big overseas-listed privatisation deals, starting with China Telecom in 1997 (now China Mobile), followed by Sinopec, Petrochina and China Unicom. It also pioneered A-share listings in China for state-owned entities including Baosteel.

But its leading position has been progressively weakened since 2005. Rivals include the well-capitalised investment banking arms of the big commercial banks, as well as securities firms such as Citic and Haitong.

Zhu junior finally quit in October last year. He was replaced by former investment banking head Bi Mingjian who had left CICC in 2005 for Hopu Capital. Describing Zhu’s tenure, one analyst told Caixin Weekly, “Overall I cannot say the company didn’t make any mistakes but neither did it make a lot of bold moves.”

The magazine says CICC’s desire to make money was always secondary to its historic sense of mission (not an accusation often levelled at global investment banks). In 2014, CICC made net profits of Rmb1.18 billion ($185.5 million). By contrast, Citic Securities made Rmb11.3 billion, almost 10 times higher.

CICC is not only smaller than Citic but some of its key financial ratios are less impressive too. For instance, in the first half of 2015 it recorded a return on average assets of 2.5% against Citic’s 3.6%.

Citic is the domestic house which has most obviously stolen CICC’s thunder, particularly after the former’s $1.25 billion acquisition of CLSA in 2012, which gave it a ready-made international investment bank.

And in recent years it has been Citic not CICC, which has been famed for financial innovations. These include its controversial cross-border equity swaps, which enabled global hedge funds to side step China’s stock market quotas and play the market as it was going up and going down.

Mind you, bankers at CICC may have looked on with a degree of vindication after a CSRC investigation led to the recent arrest of eight Citic executives over the firm’s “abnormal trading” activities during this summer’s stock market crash.

CICC has nurtured a reputation for not bending the rules, although it was temporarily banned from opening new margin trading accounts earlier this year after violating securities laws.

CEO Bi now claims CICC has been held back by a lack of capital, which its imminent listing will help to rectify. Investment banking now contributes about 20% of net profit compared to about 80% when it was first established (and versus 5% at Citic). Both firms derive the majority of their income from brokerage activities.

How will the IPO do? Given CICC has grown profits nearly fourfold between 2012 and 2014, the Financial Times Lex column reckons it is “likely to attract interest”. However, even at the bottom end of its price range it has been pitched at 1.2 times its 2015 book value, putting it on a par with Citic. The latter not only has stronger metrics, but IPOs traditionally offer a discount of at least 10% to ‘fair value’ so that they jump on listing.

Longer-term investors may be comforted by the fact that the whole brokerage sector is trading on a historically low valuation of 1.2 times forward book compared to a 1.9 times average and 3.5 times peak during 2010. Citic is down about 43% year-to-date, although it has bounced back this month in line with most emerging market assets.

One key factor besetting Hong Kong IPOs is the sheer weight of listings from the financial sector. Dealogic data shows they account for 56% of the $25.34 billion raised so far this year, up to and including Huarong Asset Management’s $2.29 billion deal.

Underwriters have responded by stuffing deals with cornerstone investors (typically these are friendly Chinese firms which will buy a chunk of shares and agree not to sell their investment for six months). In CICC’s case these will take up between 57% and 65% of the share sale depending on where it is priced – with cornerstones including the likes of China Mobile and Baosteel. With Huarong they amounted to 70.6% and before that 56% of China Reinsurance Group’s IPO. Back in August, China Railway Signal’s listing ended up with 80.7% bought by cornerstones.

China Reinsurance began trading in Hong Kong this Monday, but its debut hasn’t been encouraging so far. Having been guided towards pricing at the mid-point of the range, many institutions were wrong-footed when the deal was eventually priced at the top after a group of Chinese funds filled the book on the final day. As a result, the stock has traded sideways.

All eyes are now on Huarong – one of the asset managers set up in 1999 to purchase bad loans from the banking sector – which begins trading today. The deal was priced towards the bottom end of its range, but fund managers fear it will also perform poorly. It ended up being valued at 1.02 times forward book thanks to a regulation that does not allow IPO pricing below book value. However, its nearest comparable, Cinda Asset Management, is trading around 0.8 times 2015 book and fund managers see little real difference in value between the two.

Can CICC buck the trend? If it has learnt one thing over the past 20 years it should have been how to run an IPO. Strangely its former joint venture partner Morgan Stanley is not part of the underwriting syndicate.

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