IN ARCHITECTURE, a cornerstone is laid where two walls meet, serving as a single point from which the building takes its shape. No one constructs an entire building out of these weighty slabs. So it is meant to be in finance. To perk up interest in initial public offerings (IPOs), companies sometimes invite in “cornerstone investors”: a small number of big investors who promise to buy a stake and hold it for a while, a vote of confidence from which the IPO takes shape. Odd, then, to see a trend in Hong Kong of IPOs constructed almost entirely out of these weighty pledges.
The latest is the Postal Savings Bank of China, a lender with 500m retail customers. Its shares started trading on September 28th, capping a $7.4 billion IPO, the world’s biggest in two years. A share sale of that size would normally dominate headlines in the financial press. But this one passed quietly, and for good reason. Just a small portion of its shares were actually sold to the public. Nearly 80% went to cornerstone investors, just shy of a record.
Cornerstones, still rare in other markets, have long been a staple in Hong Kong, accounting for about 13% of total IPO values in the first decade of this century. They used to serve as a stamp of approval. Hong Kong’s best-known tycoons, such as Li Ka-shing, regularly appeared on the list of cornerstones for Chinese companies that were not yet household names.
Recently, though, they have gone from being a part of the foundation for Hong Kong deals to becoming the brickwork. This year, they have accounted for three-fifths of total IPO values (see chart). Firms that have sold more than half their offered shares to cornerstone investors in 2016 include a leasing arm of China Development Bank, a big state lender; Bank of Tianjin, a smaller bank; and Everbright Securities, a brokerage.
Companies are using cornerstones to evade market forces. Instead of bringing in savvy investors who might persuade others to hop aboard, state-owned firms are cramming in other friendly state-backed investors to ensure that their IPOs are successful. The Postal Savings Bank had six cornerstones. All were affiliated with state-owned enterprises such as China Shipbuilding Industry Corporation and Shanghai International Port Group. These are not exactly known for their Warren Buffett-like stockpicking acumen.
Cornerstone-heavy IPOs cause many distortions. Share prices are artificially high. Chinese banks already listed in Hong Kong trade at roughly a 20% discount to the book value of their assets: investors think their loan losses are higher than officially reported. But the Chinese government has a rule that state companies must sell shares at no less than their book value. Thanks to cornerstones, Postal Savings Bank was able to set a price for its IPO that just crossed the threshold, yet left its shares about 20% more expensive than its peers’. No wonder that few ordinary punters were interested. It hired 26 other banks, a record, to underwrite its IPO.
Because prices are too high, liquidity is weak after shares start trading. Cornerstone investors are contractually obliged to hold them for months (six for the Postal Savings Bank). When the time comes to sell, there are worries about a sudden flood of shares on the market—a further disincentive for other investors.
The cornerstones are a classic case of China Inc in action. The state is shifting money from pocket to pocket—from a shipbuilder to a bank in the Postal Savings case. With limited participation from outside investors, China brings little fresh capital into its listed companies. If no one is being fooled, what is the point of the charade?
An adviser who has worked on several deals says that Chinese officials see share listings less as a way for firms to raise capital than as a way to subject them to greater discipline. Whoever owns its shares, the Postal Savings Bank will need to file regular financial reports that global investors can scrutinise. The IPO’s walls are built from cornerstones, but the market at least has a window onto its inner workings.