How to hold onto your paychecks in this IPO frenzy

How to hold onto your paychecks in this IPO frenzy

Jack Ma, the former English teacher who co-founded Alibaba Group Holding Ltd. Credit: Bloomberg Photo

By Shuli Ren

Now that we’re all stuck at home, speculating on new initial public offerings has become a thrilling pastime. But as Hong Kong experiences its best IPO market in a decade, a word of caution is in order. You can lose a lot in this game, especially if you use borrowed money.

Hong Kong’s IPO market works a bit like a lottery. You borrow as much as you can to apply for as many shares as possible. With hot listings, you’re lucky to get just one out of every 100 shares you applied for. The cost is repayment of margin loans, while the upside is an IPO pop. 

Good money can be made from betting on sharp price rises of newly listed shares. In early September, more than 700,000 people bought into mineral-water bottler Nongfu Spring Co.’s $1.1 billion IPO. The stock had a 54% first-day gain and is trading over 60% above its offer price.

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About a third of the investors put in just HK$4,300 ($551) each, earning enough for a nice dim sum meal. Many investors were way more adventurous, applying for millions worth of shares to hit it big — and with debt, borrowing as much as 90% from their brokers. In the end, everyone went home happy.

With a list of companies waiting in line to dazzle us, there are a couple of things to keep in mind.

First, cornerstone investors don’t mean a thing. In Hong Kong, companies often invite heavyweights, such as sovereign wealth funds or local tycoons, to invest in the IPO as a show of confidence. It turns out, such investors don’t boost short-term returns. Looking at IPOs since 2017, those with more than 10% of shares allotted to cornerstones haven’t outperformed those without one, data compiled by Soochow Securities show.

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Earlier this week, Simcere Pharmaceutical Group Ltd posted the worst first-day decline for a $400 million-plus IPO in more than two years. Shares closed 20% lower on debut trading, despite having courted prestigious Hillhouse Capital as a cornerstone. Retail investors, who had crowded into this IPO, are nursing their wounds.

Second, valuation doesn’t matter — until one day it does. Small caps, as well as growth stocks with high price-to-earnings ratios, tend to be more popular and offer larger IPO pops. The reasoning is simple: They are proxies for hot industries, such as consumer tech or healthcare. 

We’ve seen a few cracks lately. Joy Spreader Interactive Technology Ltd., which raised HK$1.6 billion, tumbled on debut trading in September. Granted, its shares are now more than 50% above the offer price, but with an allotment rate as low as 0.07%, some investors are barely breaking even. Joy Spreader, which attracted over 360,000 applicants for its IPO shares, turned out to be a joy killer. 

Also read — With mega Ant IPO, Jack Ma becomes richer than Walmart heirs

Third, don’t ride with whales. To bet on IPO pops, you must believe someone will want to buy off your shares in the public market at a higher price. With Jack Ma’s Ant Group Co. staging the world’s biggest IPO, all eyes — and brokerage loans — will go there. Who will want your shares in some obscure company then? It’s important to check the IPO pipeline carefully.

Ultimately, a bet on an IPO pop is a bet on momentum, which has been a major factor this year and helped notch almost 39% of excess return, portfolio analysis conducted by Bloomberg shows. But be warned. In the last week, it was also the biggest losing factor. 

I get it, we’re all bored. But with as much as 10% of the city’s population betting on one IPO, I can’t help wondering if this market has gotten too frothy. Sure, we all enjoy putting money on the horses at the Jockey Club once in a while, but don’t use leverage to boost your odds. There are more productive ways to part with your paycheck.