'Kamikaze' Trades Take Shine Off Record Asia Equity Block Deals
Minutes after the market close on a Tuesday in September, a number of bankers in Asia received a phone call from Temasek Holdings looking to unload a big chunk of shares in Singapore Telecommunications.
The bankers were given just one hour to assess whether they could take on a $1 billion risk by underwriting the Singapore state investor's sell down in Southeast Asia's largest telecommunications firm by market value.
A flurry of meetings followed as bankers gathered their risk and compliance, sales and trading teams and top management to determine how aggressively they could bid.
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Such so-called block deals have become the mainstay of Asian investment banks this year, bringing relief to IPO-starved equity capital markets (ECM) bankers in the region.
The surge in block deals to a record $57.3 billion this year has shifted the focus from IPO origination teams to the syndicate desks, as pressure to execute these deals smoothly, at a profit, has risen dramatically.
The push to win mandates has led banks to propose selling shares at small discounts - a move that will please vendors but makes it harder to draw investors in and increases the risk that banks will be left holding unsold stock.
"You can't continue to do it for the league table and either not make money or lose money because after a couple of years you'll be looking for another job," said an equities banker who was not authorized to speak publicly on the matter. "You can't keep doing things at a kamikaze price and not make money."
Historically, equity deals in the Asia-Pacific accounted for nearly two-thirds of investment banking revenues, compared with under 20 percent in Europe or the United States. Overall, deals have fallen sharply as initial public offerings receded, with ECM fees in Asia ex-Japan comprising slightly more than one third of total investment banking revenues in 2012.
As a result, bankers have been forced to broker block deals to offset the more than 50 percent slump in IPO volumes this year.
To put it simply, a block deal, also known as accelerated bookbuilds, involves the sale of a large chunk of publicly traded shares after market hours. Banks buy the block of shares from sellers including private equity firms or corporates, then procure buyers among pension funds, hedge funds and asset managers, usually at a discount to the market price.
But to stay competitive in the cut-throat ECM business, banks are prone to offer slim discounts, with sometimes unhappy consequences.
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Morgan Stanley was stuck with a portion of the $350 million block of China Resources Gas Group Ltd stock it failed to sell last month, Thomson Reuters publication IFR reported. Bank of America Merrill Lynch and Credit Suisse AG were left with some shares on a $720 million sale of China Pacific Insurance (Group) Co Ltd. in July, according to IFR.
"There is always a risk that banks that are behind on the curve, behind on the game, may lean into a trade more than might be prudent," said an equity capital markets banker, who was not authorised to speak publicly on the matter. "That's where eagerness to win clouds judgment."
Goldman Sachs Group led in underwriting blocks this year in Asia ex-Japan, working on 39 deals worth $9.7 billion, closely followed by Citigroup, which handled 24 deals totaling $9 billion. UBS ranked third with $7.7 billion from 38 deals, Thomson Reuters data showed.
Hong Kong accounted for nearly half of the region's blocks business, with volumes inflated by American International Group's $14.5 billion sell downs in AIA Group. India stood at No. 2 with $5.8 billion of deals.
"If you haven't been a leading participant on block trades and made money on them, then you had a tough year," said Jonathan Penkin, head of equity capital markets for Asia ex-Japan at Goldman Sachs in Hong Kong.
Banks typically make money on blocks by charging a straight fee, similar to IPOs, or by buying the stock from the vendor at an agreed price and then selling it at a higher price. Such deals can be very profitable, but come with high risk, as underwriters often commit their balance sheets to win business as they seek to climb league table rankings.
Citigroup, for example, earned between $12 million and $15 million on Cairn Energy's $924 million block sale of Cairn India shares in September, according to Thomson Reuters estimates.
Still, volatile markets and aggressive risk bids can make block deals particularly tricky to price at a profit, as was the case when Goldman Sachs, Morgan Stanley and UBS underwrote Vodafone's $6.6 billion offering of China Mobile shares in 2010, which is still the biggest ever block deal in Asia ex-Japan.
"There are very few banks that can actually do this type of transaction and very few that have the ability to commit this sort of capital," said an equity capital markets banker who has worked on several large block offerings in the region.
"The only reason to do this is we're in the business to generate revenue for the firm."
Domino of Events
A call from a client seeking to sell a block of shares usually sparks some frantic footwork.
Banks gather some of their top personnel, including heads of sales and trading, ECM and syndicate bankers. Depending on the size, some deals may require approval right from the top at headquarters in Europe or the United States.
In the case of Vodafone, Goldman's then chief financial officer, David Viniar, and Chief Operating Officer Gary Cohn had to sign off on the deal, according to sources with knowledge of the transaction.
While making a bid, banks usually agree to a backstop price, or the minimum price at which to sell the shares, and commit to buying any unsold stock at that price. To lure investors, stocks are normally sold at a discount, which averages around 10 percent or less.
The larger the discount, the easier it is for banks to find buyers, reducing the risk there will be of any unsold stock in the block deal. But to win block mandates and please vendors, banks sometimes offer very low discounts.
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As an incentive, banks often have an "upside sharing mechanism" whereby they agree to share part of the profit with the vendor if shares are sold above the backstop price. Banks typically keep one-third of the profits, with vendors taking the rest, under that arrangement.
After winning a block mandate, banks send notes with details of the offering to their equity sales desk and those in private banking teams, who then blast the so-called term sheets to their clients. Pretty soon, orders start coming in.
"An hour after launch you have pretty good visibility if your deal is going to work," said an ECM banker, who was not authorised to speak about the matter publicly.
To mitigate potential losses, banks hedge the long positions on the stock by taking short positions on a basket of comparable companies or a benchmark index or future contracts.
Even if the underwriter loses money on a block deal, due to a drop in stock price or lack of demand, it still earns brokerage and foreign exchange commissions. The bank also dominates trading in the stock for days after the block is done, bringing in more revenue.
The banks also tend to profit by selling residual shares if the market goes up after a selldown.
"We're simply not actively lowering our standards of risk management. We're being more aggressive in how we originate, source these block opportunities," said Rupert Mitchell, head of equity syndication for Asia-Pacific at Citigroup.
Busy Year Ahead
A key measure of the success of blocks is how the stock trades immediately after a placement is completed. Any hint of unsold stock sitting with underwriters or a whiff that they struggled to generate enough demand meets with intense downside pressure when the stock resumes trading.
Underwriters are mindful not to be left holding more than 5 percent of the stock as they are then required to disclose it to the market. That gives traders a chance to short the stock, anticipating a decline when the underwriter eventually offloads the stake and creates a sudden supply of shares.
Last month, China Resources Gas tumbled 10.5 percent a day after placing new shares at an 8.2 percent discount, bruising sole underwriter Morgan Stanley. IFR reported the U.S. bank was left holding a chunk of the stock, even as sources close to the bank said the deal was fully allocated.
In July, when Carlyle Group sold a $720 million stake in China Pacific Insurance, the stock fell as much as 11.7 percent the next day, double the discount offered on that sale. Bank of America Merrill Lynch and Credit Suisse managed the Carlyle selldown.
Yet, banks are expected to aggressively pursue blocks, set to keep bankers busy next year.
Australia and New Zealand Banking Group, which has built a string of minority stakes in Asian banks, may off-load some non-strategic stakes due to stringent new capital rules, sources added.
Singapore's Temasek and Malaysian sovereign wealth fund Khazanah Nasional are also expected to keep bankers busy as they continue to churn their portfolios.
Other non-strategic stakes that bankers say are ripe for a sell down include BNP Paribas' 6 percent holding in South Korea's Shinhan Financial Group, though the French bank has shown little interest in paring its position yet.