AgBank's Easter surprise showed China IPO lure

Hong Kong investment bankers were just wrapping up work ahead of the long Easter weekend in early April when they were hit with a proposition that would upend their holiday plans.

Agricultural Bank of China (1288.HK) (601288.SS), the country's third-largest bank, was asking bankers to bid for its highly anticipated initial public offering -- one that had not been expected until later in the year, or even 2011.

Within hours, every Western bank in Hong Kong was hurriedly sending teams on flights to Beijing to prepare for the pitch session of their life -- an opportunity to underwrite what could be the largest IPO ever.

A veritable Easter parade of equity capital market bankers in Beijing tried to convince AgBank's top executives they should be selected to lead and underwrite the lender's plans to go public.

This would be the IPO prize of their careers, a deal estimated at first to target $30 billion, or nearly one-third bigger than the world's largest IPO to date.

Hundreds of million of dollars in fees were at stake.

The IPO not only reflected China's rapid growth and economic prowess, but underscored as well an emerging new order of global financial institutions.

Four years ago, Chinese banks were upstarts, lumbering newcomers saddled with bad debts and seeking the advice of Western institutions. Now, China is home to the two largest banks in the world by market capitalization, hardly blinking when the financial crisis brought Western peers to their knees.

As the last of China's major banks to go public, AgBank did not seek a Wall Street group or European lender to form a strategic partnership before the IPO. Instead, those banks threw themselves at the feet of AgBank and Chinese government officials for the chance to work on such an important deal, even if it meant earning a below-rate fee.

One banker who attended the pitch session was initially struck with how organized and prepared AgBank's executives were. Then it hit him: Agbank wanted to complete the offering in July, a little over three months away.

"It was surprising in terms of how much prep work had been done. And the time line was really aggressive," said the banker. "We didn't have enough information at the time to have us determine whether or not they could pull it off by that July time frame."

With AgBank Vice President Pan Gongsheng in charge, however, they quickly learned how this would happen.

"Dr. Pan ran this deal," said another banker involved in the deal, reflecting the respect of the bankers, who all call him "Dr. Pan."

This was the same man in charge of Industrial and Commercial Bank of China's (ICBC) world record $21.9 billion public float in 2006. The stringent rules he assigned to that process, were applied to the AgBank deal as well. And then some.

Before the Roadshow

The 10 banks selected to handle the IPO were given several requirements. One was that the banks must have at least two representatives located at all times within Beijing's three ring roads -- the main thoroughfares surrounding the Forbidden City.

AgBank executives took attendance and graded performances.

A key element in the process, according to those involved, was the willingness of AgBank's management team to fly around the world to see investors before the roadshow. They visited mutual funds in Boston, and sovereign wealth funds in the Middle East, to ensure the message was clear from the start.

"They did a pretty good job of addressing their history. If they were asked 'aren't you the worst of China's top banks?' They'd say look, we were a policy bank, but now we're becoming a commercial bank and we're interested in driving profit," one of the bankers said.

As of three years ago, AgBank had so many bad loans on its book, it was technically insolvent. People knew it as a rural lender that dished out low margin loans to farmers in accordance with state policy, and which had little or no presence in major cities.

Investors wanted to benchmark AgBank against the Bank of China, a smaller bank that trades at a lower multiple. AgBank and its advisers pushed hard to convince them to use the healthier (ICBC) and China Construction Bank (CCB) for comparison.

Thus began the classic dance between IPO seeker and fund managers. The company feels undervalued, the fund manager thinks it's overvalued. How to do that when the market was falling?

In fact, China's stock market was falling so hard and fast, talk began to bubble that AgBank might delay the offering. According to the bankers involved, this topic never came up in their discussions with the company.

"There was never really a serious discussion of do we or don't we," said one banker.

Another banker noted that once the underwriters were selected, "it was pretty clear that only a really significant event would derail the process".

Key Decision

About two and a half weeks before the roadshow, the company and its advisers made a key decision regarding the strategy of bringing in early investors into the IPO.

They decided to raise the size of the co-called cornerstone investors by a big margin.

This was meant to address the sheer size of the offering in a way that kept demand high and orders coming.

"The initial challenge is creating tension with the element of scarcity. At $23 billion, that can be pretty tough," said one banker.

Cornerstone investors are standard for Hong Kong offerings. They are not long term, strategic investors. They're not convertible bond lenders. They have the money to invest, have faith in the IPO, and can cash out anywhere between six and 12 months later.

In the past, underwriters tried to get about 25 percent of a major Hong Kong IPO allocated to cornerstone investors, usually Hong Kong tycoons and other Asia institutions who provide some backing, confidence and money to the deal before they price the IPO and sell to institutions.

With one quarter the norm, that still leaves enough of the major mutual funds of the world -- the likes of Fidelity and Wellington -- to have access to enough of the shares if they want.

But with markets dropping, the decision was made to overstack the IPO with cornerstone investors. For the underwriters, that would run the risk of upsetting top mutual fund clients who would get squeezed out by cornerstones.

A diverse enough group of cornerstone investors, however, would ensure top proceeds and give confidence to the deal, at a time when the markets weren't confident.

AgBank executives and their advisers drew up a list of top cornerstone candidates across the world. These were companies AgBank had dealt with before, had a lot of money, or were experienced in IPO investing.

Addressing the confusion from bankers as to who was leading what, AgBank appointed as its joint global coordinators -- the top role -- China International Capital Corporation (CICC), Goldman Sachs (GS.N), and Morgan Stanley (MS.N).

Morgan Stanley took on Southeast Asia to scour for investors, while Goldman looked at the Middle East. They would appoint certain banks to certain relationships.

Deutsche Bank (DBKGn.DE) began working with the Kuwaiti government, which ended up buying an $800 million cornerstone. AgBank and Goldman dealt with Qatar. Morgan Stanley brought in Temasek, while Macquarie (MQG.AX) pulled in Seven Holdings SEV.AX and UOB Bank (UOBH.SI) in Singapore as cornerstones.

Each bank earned an extra fee for bringing in the money.

The final list of Hong Kong cornerstones was arguably the largest and most diverse bunch in the history of IPOs in the city. Eleven names, committed to $5.45 billion, or more than half of the deal, excluding the overallotment.

Another 27 Chinese institutions agreed to buy into the Shanghai portion ahead of the offer.

Anchor Investors

With such a heavy cornerstone list, the underwriters realized they had created the scarcity element, but they also proceeded to anger their top mutual fund clients by dramatically reducing the amount of shares available.

"Yeah, there was a little bit of that," said one banker involved, referring to the heat from mutual funds. But, he added, the people that got squeezed in the end were the hedge funds and private banking investors, who are lower down the fund ladder.

The underwriters allowed certain mutual funds to be "anchor investors." If the long-only funds made a commitment on or before the book-building process, they would get preferential treatment.

"You always have to take care of your long-only clients," said another banker, underscoring the size and clout of the mutual fund industry and its importance to syndicate desks.

The gamble was if the long-only funds decided this wasn't worth the preference, they'd wait to see the demand before jumping in.

But they did chomp at the preference in the end, with Hong Kong's institutional book covered in the first day, and oversubscribed shortly afterward.

When it came to pricing the actual offering, it's safe to say that beating ICBC's record was certainly on the minds of those involved. The Shanghai and Hong Kong IPO price that was selected valued the company at 1.6 times book value, above where Bank of China trades.

Agbank has 30 days to decide on the overallotment. If demand is b, they will exercise the green shoe, and raise $22.1 billion, the largest-ever IPO.

If the stock falls, it may end up being a $19.3 billion IPO. That would still generate at least $200 million of fees for the banks, and the bragging rights that they worked on what was nearly the world's largest ever IPO.

Not bad for three month's work.

"It's the last of its kind," said another banker who worked on the deal, referring to big bank IPOs. "Its the end of an era for Chinese capital markets."

[Source: By Michael Flaherty, Reuters, Hong Kong, 16Jul10]

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