Markets

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

How to make HK$700,000 ($90,000) in one day? It's not as hard as you might think: More than 250 investors just did exactly that by buying into China Literature Ltd.'s initial public offering. 

IPOs are hot again in Hong Kong, underpinned by the enthusiasm of individual punters. The retail portion of China Literature's sale was more than 600 times oversubscribed, locking up at least HK$520 billion, or one-third of the city's monetary base. The public offering of auto financier Yixin Group Ltd. -- backed, like China Literature, by internet giant Tencent Holdings Ltd. -- was equally popular, while Razer Inc., the maker of computer accessories for hardcore gamers, jumped as much as 41 percent on Monday after pricing its shares near the top end of a marketed range.

Tightened Liquidity
A flurry of hot tech IPOs squeezed Hong Kong's interbank market, sending Hibor to a one-year high
Source: Bloomberg

Anyone who regards retail investors as mindless bandwagon-jumpers driving tech IPOs to irrational valuations is doing them a disservice. They are no fools: Many are wealthy individuals who have done careful math to push professional fund managers into a corner and virtually assure themselves of a no-lose bet.

China Literature is the perfect example. In the retail tranche, 277 investors applied for 7.57 million shares each, the maximum allowed. At an IPO price of HK$55 apiece, they had to be prepared to front up HK$420 million each. Granted, margin finance can be obtained to cover 90 percent (or even more) of the outlay in hot IPOs. That still means these buyers had to be ready to put in HK$42 million of their own money, just for one trade. Hardly ordinary Joes.

Each of the maximum bidders received only 17,800 shares. But that was enough to make a killing. China Literature closed 86 percent higher on its first day of trading at HK$102.40, giving their investment a value of HK$1.82 million. After deducting the HK$979,000 purchase price, 90 percent margin financing cost (HK$378 million at 1.8 percent interest for seven days, or HK$130,633) and the 1 percent IPO commission fee of HK$9,790, that leaves a profit of HK$703,297.

The annualized return works out at 87 percent -- not bad, especially if you can rinse and repeat for as long as the IPO frenzy lasts.

Ready to Pop
Investors have enthusiastically bought into technology companies this year. Banks, not so much.
Source: Bloomberg
Note: Shows the six largest IPOs in Hong Kong this year.

You need money to play this game. Anyone bidding for the minimum of 200 China Literature shares had only a 7.7 percent chance of getting any at all. Only those bidding for at least 20,000 -- an expenditure of HK$1.1 million -- were assured of an allotment.

The biggest risk to the IPO arithmetic is, of course, a first-day flop.

In cases such as China Literature, that was a remote possibility -- and the reason has to do with the interaction of retail and institutional buying. Demand for China Literature was so strong that the retail tranche of the IPO was enlarged to 33 percent, curtailing the shares available to funds. As a result, asset managers had no choice but to buy after listing. Needless to say, retail investors knew this.

Many wealthy people in Hong Kong could be classed as professional investors but will have decided they had a better chance of getting shares through the retail tranche in this offering. Sure, most have accounts in all the major investment banks across town, but they aren't necessarily VIP clients. In high-demand IPOs such as China Literature and Yixin, only the lead banks arranging the IPO can get a decent allotment of shares.

While fund managers could sit on the sidelines and wait for the IPO froth to dissipate, they are accountable to investors and faced the prospect of awkward questions if the stock were to continue to surge. Buying on the first day of trading is easier to explain. In any case, the likes of China Literature and Yixin are attractive to mutual funds because they are exposed to China's burgeoning consumer space.

Indeed, the bet was so successful that China Literature had a market cap of $11.9 billion by the first day's close. That met the early inclusion requirements of MSCI: The stock will be added to the large cap segment of the MSCI China All Shares Indexes effective Nov. 22. It will join FTSE's benchmark indexes even sooner, on Nov. 15. Soon, passive funds will have no choice but to buy as well.

So far, new economy IPOs are firing up the market. The game will continue until the first one flops. Watch for that moment -- as Gadfly's Matthew Brooker has argued, that will mark the beginning of the end.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shuli Ren in Hong Kong at sren38@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net