In Chinese mythology, dragons symbolise great power. They wield it as the deities of moving water and can generate both floods and typhoons.
Right now a very large ‘red’ dragon can be spotted in Hong Kong, thanks to a flood of capital pouring across the border into the territory’s stock market. This week marks the twentieth consecutive week of net inflows through the southbound Stock Connect scheme, which allows investors in China and Hong Kong to buy stocks listed in each other’s bourses.
Far from easing off, the deluge keeps getting stronger. Monday saw a daily record flow of HK$19.5 billion ($2.5 billion). Last week was also a record: HK$65.5 billion, almost 10% of 2020’s total inflows.
All this activity has boosted the share price of the stock market’s operator Hong Kong Exchanges & Clearing (HKEx). After a 65% surge in the past 12 months, HKEx was worth $73.4 billion as of this week. Its market capitalisation is higher than all other listed securities markets including America’s CME ($71.68 billion) and ICE ($66.02 billion), which owns 12 international exchanges including the New York Stock Exchange (NYSE).
So what’s driven HKEx’s valuation to 41 times consensus forward earnings (according to S&P Global Market Intelligence data)? And what, if anything, does that say about investors’ confidence in Hong Kong’s future as an international financial centre?
In some respects, the current stock market rally is largely about secondary markets catching up with primary markets (last year the Hang Seng Index ended 2020 down 3.8%).
This subdued secondary market performance was masked by the mass of headlines celebrating hugely successful capital raisings. Indeed 2020 was one of Hong Kong’s strongest IPO years on record: $50.3 billion was raised, second only to the Nasdaq’s $53.5 billion, according to KPMG data. HKEx would have taken the top slot if the world’s biggest (planned) IPO, aka Ant Group’s $37 billion offering, had not been pulled days before its planned trading debut in November.
Tech companies led the way in terms of cash raised in the city, followed by healthcare players. Both sectors have become important sources of fresh blood for the HKEx and that’s set to continue in 2021.
The introduction of Shanghai’s tech bourse – known as the STAR Market – in 2019 demonstrates that Hong Kong has a formidable rival close to home. Yet for the time being the new board has taken little of the shine off HKEx.
Indeed, China’s biggest unicorns are still signalling their intention to list in Hong Kong.
First off is online video-sharing app, Kuaishou, which will float before Chinese New Year on a $50 billion valuation (see WiC520). Its larger rival Bytedance is said to be planning a Hong Kong IPO for Douyin, the Chinese version of TikTok, once it has completed the latter’s sale (news on that front has gone pretty quiet – though the last reported indications were that Walmart and Oracle were the interested parties). Bytedance’s latest pre-IPO fundraising round valued it at $180 billion. Hong Kong is also likely to welcome ride-hailing app Didi Chuxing, which is valued at $60 billion.
The IPO boom has been made possible by regulatory changes at the HKEx, which allow companies with weighted-voting rights (the so-called ‘W shares’) as well as pre-revenue companies to go public. The latter change has been tailored for the fast-emerging biotech sector, and has proven a huge hit with investors.
Overall, and in less than three years, Hong Kong has become the world’s second largest listing venue behind Nasdaq. Most of these IPOs are below $500 million. Yet as the companies scale up, so will their follow-on fundraisings, helping to propel the exchange’s market capitalisation ever higher. That’s already starting to become apparent through early movers like Wuxi Biologics, which raised $3.92 billion through a series of follow-on equity offerings in 2020.
Another big story from last year was the decision by Chinese companies to either delist from US bourses or hedge their bets by establishing secondary listings in Hong Kong.
A total of nine companies, led by JD.com, NetEase and Yum China, accounted for 34% of Hong Kong’s overall IPO funding. They’ve also traded well, overcoming fears that liquidity would leach back to the US. Alibaba, the first big tech company to dual list at the end of 2019, regularly trades up to a quarter of its US turnover in Hong Kong. The ratio is even higher at 30% to 40% for NetEase.
More US-listed companies are coming, led by online entertainment platform Bilibili, which filed for a circa $3 billion IPO this week. Perhaps more symbolically, Baidu, is set to become the final member of the BAT troika to list in Hong Kong. This will be another jumbo deal which could worth more than $3.5 billion.
In a way Hong Kong is benefiting from Sino-US rivalry. And this stepped up a pace at the end of last week when China’s three telecoms majors were forcibly delisted from US exchanges after outgoing American President Donald Trump, signed an executive order banning companies that the Pentagon alleged had Chinese military connections (see WiC523 for more on the U-turns that accompanied the NYSE’s announcements relating to this controversial decision).
This week, Chinese investors responded by pouring money into China Mobile, China Unicom and China Telecom through Stock Connect. One reason for their enthusiasm was the telcos’ low valuations and stable dividend payouts. China Mobile is trading at just seven times forward earnings with a 7% dividend yield, for instance.
Chinese tech companies and SOEs are also well aware that they only have a three-year grace period ahead of another major piece of US securities legislation: the HFCAA or Holding Foreign Companies Accountable Act. This is set to outlaw listed companies that don’t permit scrutiny by America’s Public Accounting Oversight Board and requires them to disclose whether they’re owned or controlled by a foreign government.
Losing the tech companies will be a bitter pill for the NYSE and Nasdaq, given how much money they raise. Just three companies (Beke, Lufax and XPENG) accounted for 20% of NYSE IPO funds last year.
Trump’s ban on the likes of China Mobile is proving unpalatable for US investment banks too, which have spent this week delisting structured products containing the three telcos in Hong Kong. MSCI has also removed them from its indices. On the plus side HKEx should benefit markedly from the impending launch of MSCI futures in Hong Kong. The exchange is also hoping to set up a Derivatives Connect and IPO Connect.
All of these new initiatives will be taken forward by a new CEO, following the retirement of Charles Li. Local news media say the HKEx board is divided over his successor: a hire from the likes of Europe or North America might demonstrate that Hong Kong retains a global outlook; a senior Chinese dealmaker (like the outgoing boss Li) could underline the bourse’s future relationship with China.
Shortlisted candidates are rumoured to include Mark Machin, the former Goldman Sachs ECM banker who, in what must feel like another lifetime, helped China Mobile (then China Telecom) to list on the NYSE back in 1997. News website HK01.com says Machin, the president and CEO of the Canada Pension Plan Investment Board (CPPIB), is the dark horse in the race.
Other candidates include: HKEx’s interim CEO and insider Calvin Tai; its head of markets Wilfred Yiu (formerly deputy CEO of Goldman affiliate Gaohua Securities); HSBC’s vice chairman of investment banking Liu Che-ning; and former JPMorgan banker Philip Zhai.
The new CEO will oversee a greater blurring of capital between Chinese and Hong Kong. This will become even more apparent when more and more of China’s high-profile New York returnees are included in the Stock Connect scheme.
With an overall market capitalisation of its listed stocks of $6.4 trillion, Hong Kong has some way to go before it catches up with the NYSE ($26.23 trillion) and Nasdaq ($24.58 trillion). But it has momentum on its side and it has closed the gap on the Shanghai Stock Exchange ($6.62 trillion) for the first time since 2014.
Geopolitics is, of course, playing havoc with fund flows at the world’s biggest bourses.
But in a recent interview, HKEx’s ex-boss Li used another water analogy to explain that global capital cannot be indefinitely constricted by politics. “Capital belongs to the world not to the US, China, or Europe,” he said. “If you understand the sea’s power, you’ll know that it can’t be stopped.”
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