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Chinese IPOs underpriced by up to $200bn due to valuation limits

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Initial public offerings in China have undervalued companies by up to $200bn over the past six years, academic research indicates, reflecting a struggle to price listings in the world’s second-biggest equity market.

Limits on the valuations at which companies can sell shares in IPOs on most Chinese bourses mean that groups listing onshore may have raised just a quarter of what they otherwise could have, according to a working paper provided exclusively to the Financial Times by researchers at the University of Hong Kong.

Researchers determined the extent of IPO underpricing by tallying up the early share price gains across almost 1,300 market debuts from 2014 to July 2020 on the main stock exchanges in Shanghai and Shenzhen, as well as the latter’s tech-focused ChiNext market and its small business-oriented SME Board.

They found new stocks jumped on average 300 per cent on their debut following reforms in 2014, compared with just 37 per cent under a previous listings regime.

That underscores the challenges Beijing faces in making its markets more attractive for Chinese companies looking to float, analysts said. US-Sino tensions have made that task more urgent, with $1tn of Chinese equity listings at threat of being evicted from Wall Street under draft US legislation.

“We’ve not moved forward in 20 years — that, I think, is the bigger picture of what this work shows,” said Fraser Howie, an independent analyst and expert on China’s financial system.

Chinese authorities have for decades oscillated between a market-driven regime for pricing IPOs and one in which regulators have a greater say.

For about a decade after the Shanghai Stock Exchange reopened in 1990 following a more than 40-year hiatus, government regulators required most IPOs to price well below their market value. That let retail traders, who could subscribe to IPOs through a lottery system before shares hit the market, benefit from a massive jump on the first day of trading.

But by about 2009 regulators had moved towards an auction-based system for pricing IPOs more akin to those in New York, Hong Kong and London. That meant retail and other investors were far less likely to enjoy big price rises on the first day of trading.

Those reforms drew the ire of investors, according to Andrew Sinclair, a co-author of the University of Hong Kong paper.

“The idea of the IPO pop on the first day, that was something people had come to expect, but that was an artefact of inefficiencies in the market,” Mr Sinclair said. “When it became more efficient that was something that completely broke their expectations.”

China’s IPO pop returns with a vengeance

Following a chorus of criticism by local financial media and academics, which argued that the new system funnelled more money to already wealthy entrepreneurs, the China Securities Regulatory Commission in 2014 in effect imposed a limit that meant most companies could only list their stock at a maximum value of 23 times earnings per share.

Mr Sinclair said that created “a huge incentive to start listing abroad” for Chinese technology groups. Alibaba’s $25bn New York IPO in September 2014, at the time the world’s biggest, valued its stock at a price-to-earnings ratio of 40 times.

China has recently begun to experiment again with market-driven pricing for IPOs. Those on Shanghai’s tech-focused Star Market, which was hailed by state media as “China’s Nasdaq” during its launch in 2018, are not subject to valuation ceilings. Shenzhen’s ChiNext, another tech-centric market, has followed suit.

“Given all the reforms . . . companies can now sell their stocks at more market-driven prices,” said Kinger Lau, chief China equity strategist at Goldman Sachs. “I think that creates extra motivation for Chinese companies to issue.”

Yet listings on Star, which were not included in the University of Hong Kong research, have enjoyed an average day one jump of 160 per cent since the market launched, according to data from Dealogic. Shares in tech group QuantemCtek climbed a record 924 per cent on their debut in June.

By comparison, first-day IPO gains on the Nasdaq and New York Stock Exchange have averaged about 19 per cent and 12 per cent in the same timeframe, respectively.

Listings reforms put a cap on Chinese IPO valuations

Bruce Pang, head of research at investment bank China Renaissance, said that Star IPOs’ pricing reflected a “compromise” between the interests of issuing companies, retail traders and investment banks.

Star IPO sponsors must invest in the companies they bring to market with a two-year lock-up period. That is supposed to ensure bookrunners do not try to offload overpriced shares in shoddy companies to investors, but also incentivises them to price IPOs low enough to ensure a juicy return.

“If you’re a broker underwriting these listings you have to put up some of your money to invest in these companies, so you’d want more upside,” Mr Pang said.

The arrangement is not without its critics, however. Mr Howie, the independent analyst, described it as a “direct conflict of interest”.

“Ultimately it’s the companies themselves which are suffering” due to limitations on IPOs, he added. “Selling two dollars for one dollar never makes any sense.”



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Pepco and Poundland chains target multibillion valuation in IPO

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South African conglomerate Steinhoff is set to raise up to 4.6bn zlotys ($1bn) when it lists its Pepco chain of discount retailers in Warsaw this month in the latest in a series of asset sales.

Pepco, which operates about 3,200 stores in countries including Poland, Romania and Hungary, as well as Poundland in the UK, said on Wednesday that shares in the offering would be priced between 38 zlotys and 46 zlotys.

In total, Steinhoff and members of Pepco’s management team will sell 102.7m shares or 17.9 per cent of Pepco to the public, valuing the company at between 21.9bn zlotys and 26.5bn zlotys. The final price will be set on May 14, and trading will begin on May 26.

A portion of shares will also be placed directly with some of Steinhoff’s lenders, following an earlier agreement between the conglomerate and its creditors.

Andy Bond, the former Asda chief executive who now runs Pepco, intends to sell more than 1m shares in the IPO, worth roughly €9.7m at the midpoint of the price range, though he will be subject to a lock-up period until the end of 2023 thereafter.

Bond said the company planned to open a further 8,000 stores “over the longer term”, but would also keep “a clear focus on costs and delivering additional efficiencies as we grow”.

Pepco’s listing is likely to be one of the biggest this year on the Warsaw exchange, which has seen a flurry of activity since Poland’s dominant ecommerce platform Allegro raised 9.2bn zlotys last year in the country’s largest initial public offering

Steinhoff will initially retain a stake of about 82 per cent, but the group is looking to sell assets to reduce debt after an accounting scandal in 2017. 

It has already sold Bensons for Beds, another UK retailer, to private equity group Alteri, and has an option to sell a further 15.4m shares in Pepco in the offering if investors show sufficient interest. Goldman Sachs and JPMorgan are advising on the IPO.

Pepco’s business heartland is in central Europe, but the group is planning to expand elsewhere on the continent, such as Spain, and is targeting earnings before interest, tax, depreciation and amortisation of more than €1bn within the next “five to seven years”.

In the year to the end of September, it reported sales of €3.5bn and underlying ebitda of €229m. Ebitda was almost a third lower than in the previous 12 months, as the pandemic forced stores to close across Europe.

Like many other discount retailers, Pepco does not trade online, as the small size of the purchases typically made by its customers makes the economics of ecommerce difficult.

The group said last week that sales had risen 4.4 per cent in the six months to the end of March, thanks to the opening of more than 200 new stores. However, on a like-for-like basis, sales were down 2.1 per cent.



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Honest Company’s market debut marks a comeback

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When the Honest Company lists on the Nasdaq exchange on Wednesday, it will be the culmination of a long recovery for the baby and beauty products group co-founded and fronted by the actress Jessica Alba.

The company priced its initial public offering on Tuesday at a valuation of $1.4bn, having worked to shake off much of the reputational and financial damage from a series of product lawsuits and recalls.

Honest, founded in 2011, had been valued as high as $1.7bn in 2015 before controversy over some of its claims to be using only natural ingredients in its products. In 2017, the company also recalled baby wipes because it found mould in some packages, and baby powder over concerns it may cause skin or eye infections.

Sales slid and Honest lost its status as a “unicorn”, a private company worth more than $1bn.

“Our rapid growth,” Alba wrote in a confessional passage in the IPO prospectus, “was compromising key business functions.”

Honest has never been profitable, but its revenue rose from $236m in 2019 to $300m in 2020 as the pandemic fuelled a run on cleaning products and other household staples. That took sales back to the level the company last enjoyed in 2016.

Losses narrowed last year to $14m from $31m in 2019.

Honest has previously said it expected to price its offering between $14 and $17 a share. At $16 each, it raised $413m, a majority of which will go to existing investors who are selling some of their stake.

Alba had been inspired to launch the brand after the birth of her first child left her scrambling to find household products she deemed safe to use around her daughter. She pledged to hold the company to an “honest standard of safety and transparency”.

Honest markets its products as natural, boasting that “we ban over 2,500 questionable ingredients”. It is one of many consumer goods makers seeking to tap into buyers’ appetite for household products seen as non-synthetic and sustainable.

The company still flags “health and safety incidents or advertising inaccuracies” as a continued risk factor in its prospectus. In January the brand issued a voluntary recall for one of its bubble baths, out of concerns that it could cause infections.

Ahead of the IPO, the company said two weeks ago that Alba would be stepping down as chair of the board when the company lists, handing the role to James White, former chief executive of Jamba Juice. She will remain the company’s chief creative officer, on a salary of $600,000 a year and, according to the prospectus, key to the company’s future success.

“Jessica Alba is a globally recognised Latina business leader, entrepreneur, advocate, actress and New York Times bestselling author,” it said. “Our brand may . . . depend on the positive image and public popularity of Ms Alba to maintain and increase brand recognition.”

Alba’s 6.1 per cent stake after the IPO was worth about $90m at Tuesday’s offer price.

The 3.8 per cent stake held by chief executive Nick Vlahos was valued at $57m. Vlahos has been steering Honest’s recovery since 2017, when he replaced co-founder and serial entrepreneur Brian Lee.

Honest secured a $200m investment from the consumer-focused private equity group L Catterton in 2018. The group is selling about half of its current 37.1 per cent stake in the offering, enough to recoup that investment, leaving a 17.4 per cent holding worth another $252m.

Morgan Stanley, JPMorgan and Jefferies are leading the offering.



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Oxford Nanopore/IPO: sequencer has Woodford in its DNA

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The stampede of pandemic winners to the stock market inspires wariness. Oxford Nanopore, which plans to go public this year, is one such beneficiary. The spinout from Oxford university is responsible for a fifth of the international sequencing that tracked coronavirus mutations.

That has drawn attention to a company with a lot of potential in a wide range of applications. An initial public offering could value it at significantly more than the £2.5bn price tag from a private funding round on Tuesday.

Started in 2005, Oxford Nanopore has benefited from the support of long-term shareholders. However, the backing of Neil Woodford is a complicating factor. The funds business of the prominent UK asset manager folded in 2019 following dire performance.

A successful float would benefit Schroder UK Public Private, the “patient capital” investment trust Woodford formerly ran. But there will be anger from former investors in his defunct income fund. Its 6 per cent stake in Oxford Nanopore was bought by Nasdaq-listed Acacia Research, which put a valuation of just $111m on it in its latest accounts. Woodford, who announced a controversial plan to restart his career in February, is working with Acacia as an adviser.

Oxford Nanopore’s decision to join the London market rather than Nasdaq will also hamper the valuation. But assume, as Jefferies does, that sales more than doubled to £115m in 2020. Even if Oxford Nanopore was valued at half the multiple of peers like US Pacific Biosciences, it would be worth £3.6bn.

That is less than a tenth of the size of San Diego’s Illumina, the global leader. Oxford Nanopore argues its sequencing technology — which monitors changes to an electrical current as nucleic acids are passed through a tiny hole — beats traditional camera-based approaches. Sequencing can be done quickly and cheaply by miniaturised devices. Accuracy has been a weak point, but is improving.

Investors should focus on the science, setting aside market froth and the Woodford connection. At the right price, Oxford Nanopore’s plan to facilitate the analysis of “anything, by anyone, anywhere” would be worth investing in.

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