Stop the BoCom placing: get a rights issue
16 March 2012
Yesterday Bank of Communications Co Ltd (BoCom, 3328) launched a proposed HK$69.33bn (US$8.93bn) placing of A-shares and H-shares, subject to shareholders' approval, kicking off the latest round of fund-raising in the mainland banking system, which has been stretched by the great state-commanded lending binge of 2009. Expect much more of this in other banks as those loans start to go sour.
The new shares are equal to 20% of the existing shares, but it's not like any ordinary placing. This is in reality a set of connected transactions in which the 3 largest shareholders get to maintain or increase their shareholdings, a few new shareholders are hand-picked, and everybody else gets diluted. In China, some shareholders are more equal than others. Here are the holdings of the top 3, in H-shares and total shares, if the deal proceeds:
|PRC Ministry of Finance (MOF)||13.01||13.01||26.52||26.53|
|HSBC Holdings plc (HSBC)||40.37||40.37||19.03||19.03|
|National Council for Social Security Fund (SSF)||24.09||24.09||11.36||13.88|
Now each of these 3 subscriptions is a related party transaction, requiring the approval of independent shareholders under Shanghai Stock Exchange (SSE) Listing Rules. Two of them are also connected transactions under HK listing rules, because a person holding more than 10% is a connected person. One of them, MOF, is exempt, because there is a loophole in the HK Listing Rules which exempts "PRC Governmental Bodies" from the connected transaction rules.
Regulatory note: the exemption of PRC Governmental bodies should be abolished. If Shanghai does not see fit to exempt the Government from connected transaction rules, then why does HK? We first wrote about this loophole back in 1999.
But here's the bigger problem: according to yesterday's announcement, the MOF will abstain from voting on its own subscription, HSBC will abstain from voting on its own subscription, and SSF will do likewise. But this says nothing about their ability to vote in favour of each other's subscriptions. So add up the pair that can vote and divide by the percentage not owned by the subscriber, and you will see that there will be at least 41.36% in favour of MOF, 46.21% in favour of HSBC and 50.81% in favour of SSF. In reality the percentages will be higher because not all shareholders vote.
This sets a dangerous precedent, because many listed companies have more than one substantial shareholder (your editor is a substantial shareholder of one) and it would allow 2 or more substantial shareholders to engage in this mutual back-scratching where "I'll support your subscription and you support mine", leaving outside shareholders in the cold. So we urge SEHK and SSE to review the voting requirements for BoCom and require that all 3 of the substantial shareholders should abstain from voting on all 3 subscriptions.
Thankfully, this problem is mitigated by the fact that unlike many companies, BoCom does not already have a general mandate to issue shares, so not only are the 3 related-party subscriptions subject to shareholders' approval, but so is the entire placing. The announcement states that each of MOF, HSBC and SSF (as well as two other related parties) will abstain from voting on the special resolution in respect of the proposed issuance and placing, leaving it open to independent shareholders to veto the deal. However, it also states that if the placing is not completed by the Annual General Meeting (which last year was held on 28th June) then they will refresh the General Mandate then, and it is unclear whether the conflicted shareholders will abstain from voting on the refreshment of the mandate.
Regulatory note: In mainland China, the general mandate to issue shares for cash without a rights issue, thereby diluting your existing shareowners, requires a special resolution (2/3, or 66.67% majority), a tighter standard than HK (ordinary resolution, 50% majority) but behind the UK (special resolution, 75% majority). So pre-emptive rights are another area in which mainland rules are ahead of HK, along with quarterly financial reporting.
This placing is a shoddy way to treat independent shareholders. BoCom has said that mainland regulations prevent the issue of shares below the net asset value of the bank. For BoCom that is RMB4.16 per share at 30-Sep-2011 (the 2011 results are not yet out). At yesterday's exchange rate that is about HK$5.10, versus a share price of $6.19. BoCom has claimed that this makes a rights issue infeasible as the discount would be too shallow.
The mainland NAV rule makes no sense when applied to rights issues, because in rights issues there is no unfair dilution of the NAV belonging to existing holders, because everyone gets to participate or sell their rights, thereby receiving the full value of the discount. The discount in a rights issue just amounts to a partial bonus issue, and bonus issues are allowed under mainland law (BoCom itself did a 1 for 10 bonus issue in 2011).
So to get around this rather primitive rule on NAV, they could do a 1 for 5 rights issue at say $6.19 (the market price) with 1 bonus share for each rights share subscribed. That would be equivalent to a 2 for 5 issue at $3.095, a 50% discount. No underwriting would be necessary with such a deep discount.
Thanks to the lack of a pre-existing general mandate, independent shareholders now have the opportunity to stop this placing and call for a rights issue by voting against the special resolution at the EGM, on which the big 3 shareholders will abstain. We urge you to do so.
Unfortunately for international investors, the number of H-shares which can vote on the special resolution is about 6,574m, while the number of A-shares which can vote is about 19,283m, and many of those will be in the hands of state-controlled fund management companies who tend to do as they are told. So the voting entitlements are about 25.4% H-shares and 74.6% A-shares. Not all of them will vote, so it is possible to get the 1/3 (33.33%) of the votes necessary to stop the placing, but it will be a struggle.
© Webb-site.com, 2012