In Hong Kong IPOs, Big Bang Stands for Buyer Beware

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(Bloomberg Gadfly) -- Hong Kong’s stock market is about to get a lot bigger, sexier – and riskier.

A flood of hot China tech and biotech listings is heading for the former British colony, in a blow to the New York and Nasdaq exchanges that have hitherto attracted many of the mainland’s choice new-economy flotations.

Amid the excitement, investors should watch their step.

Hong Kong Exchanges & Clearing Ltd. will allow innovative companies that use shares with weighted voting rights to apply for IPOs starting April 30, and will also admit unprofitable biotech firms. That’s a landmark departure from the exchange’s longstanding adherence to the one-share-one-vote principle and the requirement for a three-year profit track record.

China has also opened the door for companies listed on its National Equities Exchange and Quotations market – an over-the-counter trading venue that’s developed something of a reputation as a casino – to sell H shares in Hong Kong.

Looser entry rules will create a vastly different market.

The relaxation gives Hong Kong a shot at attracting the next Alibaba Group Holding Ltd. – or even the current one, if the e-commerce giant chooses to do a secondary listing. Biotech stars such as the Jeff Bezos-backed cancer-detection startup Grail Inc. are already heading for the city. Other likely candidates include smartphone maker Xiaomi Corp., Alibaba affiliate Ant Financial Services Group and Lufax, the peer-to-peer lending unit of Ping An Insurance (Group) Co. Those three between them could add $300 billion to Hong Kong’s market capitalization.

The biggest buzz surrounds biotech. Shanghai-listed Jiangsu Hengrui Medicine Co.,  which has one of the largest sales forces for oncology drugs in China, is up 80 percent in the past year. Companies like Shanghai-based Zai Lab Ltd., an unprofitable biopharmaceutical firm that sold shares in the U.S. last year, may now opt for Hong Kong. Such listings could see the city reclaim its crown as the home of Chinese tech listings, a title lost when Alibaba decamped to New York in 2014.

Wary of opening the gate too wide, Hong Kong has put in some safeguards. Biotech listing candidates need to have a market value of at least HK$1.5 billion (US$191 million) and at least one product that has completed phase-one clinical trials. They will also be subject to more stringent disclosure requirements. Those weighted-voting rights have a time limit, too: If a founder loses control, they will expire.

These protections may not be enough, though. In the U.S., which has a disclosure-based system that allows pretty much any hopeful to list as long as all relevant information is made public, shareholders have recourse to class-action lawsuits when companies misbehave. Investors in Hong Kong and China don’t have that option. That makes the role of gatekeeper paramount.

The exchange’s listing committee and the Securities and Futures Commission vet listings in Hong Kong, with the China Securities Regulatory Commission fulfilling the function in the mainland. The SFC opposed dual-class shares in Hong Kong, though ultimately lost the battle. Some investors may see that as reason for caution.

Dual-class structures mean that founders’ interests may not always align with those of other shareholders – a familiar issue in Asia, with its concentration of family-controlled businesses.

Biotech is also a volatile and risky sector. Firms may spend millions on drugs that turn out to be duds. Wild swings in stock prices are common as traders speculate on who will come up with the next blockbuster. Zai Lab, for instance, surged almost 90 percent a month after listing on Nasdaq in September. The shares are now back where they started at $18.

Even as Hong Kong has opened the gates, China has remained somewhat wary. Its overseas-listed tech companies will be able to sell stock in the mainland through Chinese depositary receipts – but only those that are valued at more than 200 billion yuan ($32 billion). Hong Kong will permit companies with a market value of less than HK$40 billion ($5 billion) to have weighted voting rights, as long as they have revenue of HK$1 billion in the past year.

There’s a big bang coming, and doubtless the bulk of these IPOs will soar, given the paucity of new-economy options in the Hong Kong market. Mainland investors trading through the connect pipes that link the Shanghai and Shenzhen exchanges with Hong Kong are likely to be especially keen.

Just remember: It’s buyer beware.

 

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

©2018 Bloomberg L.P.

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