China Telecom’s 1997 IPO is remembered as a pivotal moment in China’s engagement with the global capital markets, smashing size records and sowing the seed for big listings from the country’s public sector. The origins of the deal, however, trace back to Hong Kong’s red-chip fever in the mid-1990s.
Red chips, the name for Chinese companies incorporated overseas and listed in Hong Kong, have played an important part in Hong Kong’s market development in the past 20 years.
The first batch of IPOs emerged in 1992, giving overseas investors their first opportunity to invest in a Chinese economy that was booming under the reforms of Deng Xiaoping. The idea caught on, and red-chip listings quickly became the city’s most popular.
Efforts to introduce the new product had in fact started years earlier.
“We started educating potential issuers since around 1987. We had to tell them what capital markets were, the pros and cons of being a listed company, what the potential risk is and what issues they had to pay attention to during the listing,” said veteran investment banker Francis Leung Pak-to, known as the “father of red chips”.
Red-chip fever took hold in earnest when Deng Xiaoping made his famous tour of southern China in 1992. During the trip, the officially retired leader reiterated the need to continue on the path of economic reform and openness.
Some Chinese companies interpreted that message as a sign of the government’s support for further economic liberalisation and turned to the international capital markets to fund their expansion. China Overseas Land & Investment and Yuexiu Property, for example, listed in 1992. Both were incorporated overseas but their listings only involved Hong Kong assets.
A new shade of red
The next breakthrough came in June 1997 when Beijing Enterprises listed in Hong Kong.
“Unlike the window companies of other first-tier municipal governments, Beijing Enterprises and its parent company had no substantial assets before listing. We packaged certain mainland assets including toll road, beer and dairy businesses and injected them into the company and helped them list outside of China,” said Leung.
The investment vehicle of the Beijing municipal government started trading just a month before the handover of Hong Kong to China, after an overwhelming response to its US$240m IPO. The stock closed at HK$40.20 on the first day, 222% above the IPO price of HK$12.48.
The frenzy drew the attention of the Chinese regulators, and new guidance in 1997 directed domestic companies to seek approval before listing red-chip subsidiaries overseas.
“The guidance immediately cooled the red-chip IPO market. Some big state-owned enterprises, however, were still eager to take the red-chip route as it’s more flexible to raise funds after listing. The previous successful red-chip listings had also aroused international investors’ interest,” said Leung.
The curbs made the Hong Kong and New York listing of China Telecom, since renamed China Mobile, even more significant. At US$4.2bn, the October 1997 dual listing was China’s first major international IPO, and by far the biggest from the state sector. With mainland regulators watching closely, the future of the entire red-chip sector was at stake.
To complicate matters further, the fallout from that summer’s currency devaluations in South-East Asia was spreading around the region.
Nonetheless, China Telecom proved too hard to resist. CICC and Goldman Sachs, joint bookrunners on the deal, went out with guidance of HK$7.75–$10.00 per share, but hiked it to HK$9.50–$12.60 as momentum built, eventually pricing at HK$11.80.
Market conditions, however, deteriorated quickly before the stock started trading.
“The month before China Telecom listed, the red-chip bubble started unwinding, and the week it listed, everything else started unwinding. The Hang Seng index started unwinding and that was the start of the contagion of the Asian financial crisis into the Hong Kong market,” said Mark Machin, who worked on the deal during a 20-year career at Goldman Sachs and is now president and chief executive officer of Canada Pension Plan Investment Board.
The stock listed in Hong Kong on October 23, on a day the Hang Seng index sank 10.4%. Despite that setback, China Telecom recovered to end the week 3% above the IPO price.
“We had every senior person lined up behind the head trader on the trading desk, watching the trading for the first few hours and making sure everything went smoothly,” said Machin.
The listing of the first Chinese “national champion” cleared the way for others to follow from the aluminium, energy and financial sectors. CNOOC listed in 2001 while China Network Communications Group followed in 2004, both in the form of red chips.
Investors now have other ways of owning a piece of China’s growth story, and tougher mainland controls over red chips mean fewer and fewer SOEs are listed in this format. Privately owned companies, however, still like to list as red chips as it gives them greater financing flexibility.
At the end of May 2017, there were 158 red-chip companies listed on the SEHK with a combined market capitalisation of HK$5.4trn (US$692bn), according to data from the stock exchange. In total, there were 2,027 listed companies in Hong Kong at that date, with a combined market cap of HK$28.5trn.
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