China's B-share exodus

Originally desogned to attract foreign investors but increasingly losing its relevance, China's moribund B-share market has long been the equities equivalent of the walking dead. But the last few months have been an exception - the Shanghai Stock Exchange B-share Index has risen 20% since July while its Shenzhen counterpart is up 30%. The Shanghai Composite Index has gained a fraction of this amount during the same period.

The surge has been driven by the listing of China International Marine Containers (CIMC) in Hong Kong after converting its Shenzhen-listed B-shares. Through this first-of-its-kind transaction, Hony Capital - which was selected in July to provide the cash option for shareholders who rejected the conversion listing - secured a 5.16% stake, or 137 million shares, at HK$9.83 apiece.

CIMC opened on its Hong Kong debut at HK$12.60 and closed at HK$11.22, an increase of 29.9% and 15.7%, respectively, on its last B-share price. As January 8, Hony Capital has already made a 1.5x unrealized return on its initial HK$1.34 billion ($173 million) investment.

This is certainly not a one-off event. At least two more companies are reportedly trying to engineer the same B-share to H-share conversion. China Vanke, the country's largest listed developer by market value, suspended trading in both its B-shares and renminbi-denominated A-shares since December 26. Around $2.1 billion of its Shenzhen-listed B-shares are expected to migrate to Hong Kong. This week Livzon Pharmaceutical Group also halted trading, pending a major announcement. Analysts speculate that it too may follow the CIMC model.

"We expect to see more companies converting their B-shares into H-shares in the future and are ready to put our experience with CIMC to use in advising these companies," says Raymond Li, partner and Greater China chairman of Paul Hastings, the legal adviser on CIMC's conversion.

An irresistible switch

B-shares, which trade in Hong Kong dollars in Shenzhen and in US dollars in Shanghai, were established in 1992 as the sole channel for foreign investors to enter China's stock markets. Within a year, though, their importance dwindled as China-incorporated companies listed in Hong Kong as H-shares. Then in 2002, the government launched the Qualified Foreign Institutional Investor (QFII) program, allowing licensed overseas investors to trade A-shares.

A total of 54 companies trade on Shanghai's B-share market and a further 53 in Shenzhen. For several years the Chinese government has been trying to come up with ways to rejuvenate the increasingly obsolete asset class.

A-share and B-share integration seems unlikely given that it would fully open up domestic equities to overseas investors. Absent this option, Edward Au, partner and co-leader of Deloitte's national public offering group, tells AVCJ that there are currently three ways for companies to get rid of their B-shares: a privatization, a relisting, or a B-to-H conversion.

"While it is uncertain whether an IPO can take place in Hong Kong after a B-share privatization, converting B-shares into H-shares is the preferred option for companies that continue to look for public funding with minimal time and financial costs," he says. "CIMC, for example, only took five months to complete the whole migration."

Au adds that switching to the H-share market also leads to better valuations. In the light of thin trading volumes and limited investor interest, valuations of B-share companies are generally lower than those in the A- or H-share markets. For example, Vanke's B-shares were trading at about 9x forward earnings prior to their suspension, compared to 13x for Hong Kong-listed China Overseas Land & Investment.

It is thought that around 40 B-share companies, which concurrently meet the listing requirements of the Hong Kong Stock Exchange, may complete the transition.

PE participation

While securities regulators in Hong Kong and China are apparently supportive of the process, a bigger challenge lies in finding an established and sizable independent third party to provide cash options for shareholders who are reluctant to hold the shares post-conversion.

"Under CIMC's share conversion scheme, one of the requirements is that there should be neither upper nor lower limits on how much the third party can purchase through the cash option," says Donny Wong, managing director of GuotaiJunan, sole sponsor of the listing.

China Merchants Investment and COSCO Container Industries - two major shareholders in CIMC - agreed to give up their rights to exercise the cash options, but the holdings of other third-party investors amounted to 577 million B-shares, representing HK$5.6 billion ($731 million).

This explains why Hony Capital was chosen. A subsidiary of Hony Capital Fund V - one of the largest US dollar-denominated vehicles in China at $2.4 billion - was responsible for providing the cash option. The private equity player is also expected to provide financial advisory services to CIMC, leveraging its extensive experience investing in Hong Kong-listed companies.

Hony's investment may suggest that other PE firms with a large US-dollar funds and H-share investment expertise would be in a better position to take advantage of the B-to-H conversion. However, Deloitte's Au says the trend is unlikely to catch on because this kind of short-term bridge financing doesn't fit well with traditional private equity investment objectives.

GuotaiJunan's Wong adds that while the B-share markets have posted substantial gains in recent weeks, it is unclear whether other B-to-H migrations could provide similar returns that Hony has achieved with CIMC. The fundamentals of the investment target remain the key factor.

"As this is the first-ever conversion, Hony didn't know how much it could earn through the valuation gap - there was a chance that the price could fall," says Wong. "But CIMC is the world's leading freight container manufacturer globally so the PE firm was won over by its market share."

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• Topics
• Greater China
• Regulation
• China
• Hony Capital
• regulation