Hong Kong IPOs: Open season

The genesis of Hong Kong’s Growth Enterprise Market (GEM) was a proposal drawn up in the early 1980s by a government-appointed committee tasked with devising ways to remake the territory as a financial center. The committee envisaged an exchange, open to professional investors only, for brokering private stock sales, thereby enabling early-stage investors to sell to private equity players who would then guide start-ups to IPO. When GEM launched in 1999 it was a very different creature.

The initial proposal unveiled last year for an additional board – which will feature loosened listing requirements, making it easier for the Hong Kong Stock Exchange (HKEx) to attract IPOs by Chinese technology companies – suggested a similar structure. Listing candidates that don’t meet the standard financial criteria would trade on a board with a lighter touch approach to listing requirements and open to professional investors, while those that do would feature on a board open to all.

The two-segment approach was abandoned when investor feedback indicated a preference for pre-profit issuers being subject to more stringent regulatory standards and a higher minimum market capitalization threshold than those suggested and for retail investor participation. It was noted that a board that included small companies tracked by relatively few investors would likely have poor secondary market liquidity.

The system likely to be implemented will expose investors to a different kind of company: one that is harder to value (unprofitable at time of listing, but with the potential of strong performance thanks to the fundamentals of high-growth industries); and has compromised governance (weighted voting rights, WVR, that usually enable the company founder to retain control even after his equity interest has been diluted by multiple sales of new shares to external investors).

The move is essentially competitive in nature, moving Hong Kong more in line with global norms so it can attract listing candidates that are currently beyond its reach, hence the plan to allow secondary listings by Chinese companies that already went public elsewhere because they couldn’t do so in Hong Kong. While it started with Alibaba’s $25 billion IPO – the e-commerce giant was interested in a Hong Kong listing, but the exchange refused to budge on governance – the impact could be wide-ranging.

HKEx noted in its concept paper published last year that 68% of IPOs in the US in 2016 involved pre-profit companies, up from 24% in 1980, with a strong bias towards technology and biotech. The new economy contribution to the market capitalization of the New York Stock Exchange is 47%, compared to 3% for Hong Kong. Financial services and property make up 44% of HKEx’s market cap; pharmaceuticals, biotechnology and life sciences is on 1% and software and services on 9% (1% if Tencent is excluded).

Furthermore, while only 33 out of the 116 mainland companies with primary listings in the US as of June 2017 had WVR structures, their combined market capitalization of $561 billion represented 84% of the market value of all US-listed mainland companies. IT-related businesses accounted for 18 of the 33 and 84% of their market capitalization.

Hong Kong is already attracting Chinese technology companies that meet current listing requirements, such as Meitu and China Literature. While the exchange is poised to lower the bar for admission, there will be safeguards: for example, pre-profit companies will be limited to biotech and WVR interests in companies deemed suitable for that kind of listing will be capped; and candidates in both categories will be subject to minimum market capitalization and enhanced disclosure or governance requirements.

That said, the roll-out of such a substantial reform is unlikely to be trouble-free. Investors, particularly on the retail side, will flock to these new economy businesses, pushing valuations to unsustainable highs without thinking through the risk factors. HKEx may be limiting the dosage in the initial stages, but it is still introducing a new concept to the market. More so than in other sectors, not all companies that make it to the bourse will manage to live up to the hype.

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• Topics
• Greater China
• IPO
• Regulation
• Technology
• Healthcare
• Hong Kong (China)
• Exit
• TMT