Timing is key to ABC's IPO

Investors in property and equities are not the only ones spooked by China’s policy shift to tightening and the impact this may have on liquidity – a domestic banking conglomerate is also growing more worried.

Agricultural Bank of China (ABC) is generally regarded as the shakiest of China’s Big Four state-owned banks due to its exposure to the rural sector – indeed it wasn’t decided until relatively recently that ABC would be a commercial rather than a policy lender. The bank is eyeing a massive initial public offering in Shanghai and Hong Kong in July or even earlier, well ahead of its original plan of late in the second half, according to media reports.

The stepped-up efforts came after a slew of its rivals have announced mega-sized fund-raising proposals as financial authorities demanded an improvement in capital strength after a lending spree last year.

More than a dozen Chinese banks are expected to raise more than US$60 billion between them in the next few months. Among them, China Construction Bank (CCB; 601939.SH, 0939.HK) announced a plan earlier in May to collect up to US$11 billion in a rights issue. Industrial & Commercial Bank of China (ICBC; 601398.SH, 1398.HK) this week appointed four investment banks to handle a proposed additional equity sale worth US$7-10 billion. Bank of China (601988.SH, 3988.HK) is looking to raise up to US$5.9 billion through a convertible bond issue in Shanghai.

Smaller lenders, including Bank of Communications (601328.SH, 3328.HK), China Merchants Bank (600036.SH, 3968.HK), Shenzhen Development Bank (000001.SZ) and Huaxia Bank (600015.SH), have also unveiled fundraising proposals, mostly right offerings and private placements.

ABC’s response – lifting the estimated size of the dual listing to about US$30 billion from the previously projected US$20 billion – might be seen as s sign of confidence, but it is not. The larger target just reflects the bank’s concerns that the IPO will be its only fundraising opportunity in the next few years. It wants to get in big and early in order to soak up as much liquidity as possible before its rivals join the fray.

The listing also coincides with mounting concerns about overheating after China’s economy expanded at its fastest pace in six years in the first quarter of 2010 and consumer price growth continues to accelerate. As a result, the benchmark Shanghai Composite Index has become Asia’s worst-performing gauge this year by dipping about 20 percent so far this year.

It is not unreasonable to suggest that ABC’s timing – whether the IPO is in two months or five months – is poor. But there are some lessons the bank can learn from previous listings, which might ease its path to the market.

First of all, it is wise to sell shares in Shanghai and Hong Kong simultaneously. ICBC did this and reaped the rewards; China Pacific Insurance listed in Shanghai first and then had to wait two years to go public in Hong Kong because a sustained decline in the Shanghai-listed shares affected the pricing of the new deal.

Second, in the absence of foreign strategic investors, ABC needs to bring some cornerstone investors ahead of its IPO. The success of the Hong Kong listing may depend on having clout behind it, especially if the market conditions are difficult.

It has been reported that investment banks, including Deutsche Bank (DB.NYSE, DBK.FWB) and J.P. Morgan (JPM.NYSE), have invited US hedge funds and China-focused private equity funds to meet top management at ABC to discuss possible IPO investments.

Even if a string of high-profile cornerstone investors isn’t enough to instill confidence among smaller investors, ABC always has the central government to fall back on.

This IPO is the final act of a decade-long drama that has seen the Big Four recapitalized, reconditioned and launched in the capital markets. Only small portions of CCB, BoC and ICBC are publicly listed and the quality of their corporate governance is still much debated, but the banks have emerged as some of the world’s largest financial institutions.

For Beijing, a successful ABC listing completes the reform process as well as underlining the government’s commitment to supporting agriculture-related sectors.

China Central Huijin – a domestic investment arm controlled by China Investment Corp – has already injected US$20 billion in ABC to help it shed bad loans and undergo restricting. Central Huijin would likely step in to buy shares of ABC and other big lenders to help stabilize the market.

Beijing also has no reason for wanting ABC to dally. Property prices remain high despite austerity measures gradually introduced since the start of the year. It is likely that government will tighten the screw in the second half of 2010, prompting further weakness in the equity market.

These measures are also likely to target banks specifically, with increases in the proportion of assets that lenders must hold in reserve – and this may require institutions to raise their capital adequacy ratios. In this sense, ABC has to move as early as possible.