Move over Toronto: here comes Hong Kong

Before SouthGobi Energy Resources (SGI-T) completed its secondary listing on the Stock Exchange of Hong Kong (HKEx) on Jan. 29, the Vancouver-based coal miner’s average daily turnover on the Toronto Stock Exchange was about US$272,000. After listing in Hong Kong its turnover on the TSX rocketed to US$2.2 million.

SouthGobi’s daily turnover for the month of February in Hong Kong reached US$9 million. In total the company, which produces coal in Mongolia, raised US$393 million on the HKEx and boasts a market capitalization there of about US$2.49 billion.

Two days prior to SouthGobi’s listing, United Co. Rusal of Russia, the world’s largest aluminum producer, also listed on the HKEx, raising US$2.2 billion. As of Feb. 26 it had a market capitalization of US$15.23 billion. Rusal’s share price

fell sharply after listing, but the view in Russia appears to be that the listing was a success and the debt-ridden aluminum company got a remarkably good valuation.

“We’re seeing a lot of buzz around the mining sector in Hong Kong,” says Stanley Chow, a corporate partner at Latham & Watkins in Hong Kong, who is currently working on several mining-related IPOs. “The story is China’s thirst for resources and investors are supporting these stocks. Mining is a hot sector right now.”

Historically, companies tended to list on stock exchanges in the West. Today that is changing and the choice of a listing destination includes the liquidity of a stock market, access to cornerstone investors, and appealing valuations.

“Companies are waking up to the fact that there are markets outside North America,” Ronald Arculli, chairman of Hong Kong Exchanges and Clearing, explained in an interview on the sidelines of the recent Prospectors and Developers Association of Canada convention in Toronto. “And companies are rewarded by the multiples. The average P/E ratio in Hong Kong is eighteen times.”

As competition for listings heats up amongst stock exchanges, the exposure a Hong Kong listing gives mining companies to the deep pool of capital in China and Asia-wide will become an important selling point, not to mention the generally higher valuations available in Hong Kong, partly because there are so few mining companies listed there compared with exchanges elsewhere. According to Chow, if a company trades at eight times earnings in London, for example, it might trade at 10 times earnings in Hong Kong.

“The real capital is in Asia,” asserts Assif Shameen, an economics reporter based in Singapore who has covered Asian business for more than two decades. “China is sitting on over US$2 trillion; if you add in Hong Kong, Korea, Taiwan, Japan, Singapore and others you get another US$2 trillion. So there’s a lot of money here in Asia to pay for companies that need to grow. What we’re seeing is a seismic shift of financial power from West to East.”

Currently there are 100-million-plus investors in China and domestic household bank deposits of roughly RMB20 trillion, the equivalent of about $3 trillion. And that’s not the total domestic wealth, which is probably three times higher than that, estimates Arculli. “The local retail investor base is huge and the institutional base we have includes Chinese institutions, fund management companies and sovereign wealth funds.”

Last year, the HKEx raised more IPO funds than any other stock exchange in the world (US$32 billion). Average daily turnover on the exchange last year reached US$8 billion. On the TSX the comparable figure was just US$4.9 billion.

“Hong Kong had a fantastic year last year in terms of capital raising,” Chow says. “Many markets were effectively closed last year but Hong Kong did very well.” Mark Banovich, managing partner in the Moscow offices of Latham & Watkins, agrees. “Some of the publicly listed Chinese corporates are said to be considering almost strategic-sized investments in these IPOs. I think that’s driving part of the interest in a Hong Kong listing.”

Rusal is the first Russian company to list in Hong Kong but it certainly won’t be the last. Reuters news agency reported on Feb. 17 that Russian oligarch Viktor Vekselberg aims to follow countryman and fellow billionaire Oleg Deripaska of Rusal into the Hong Kong stock market with an initial public offering for his gold business, Kamchatka Gold, in the fourth quarter of this year. The news agency was quoting from an interview with Vekselberg that appeared on the Russia Today TV channel. There are also rumours that PetroPavlov, a Russian iron ore miner, may seek a listing.

There’s also growing interest in Australia. In early February, Bloomberg news agency reported that Australian billionaire Clive Palmer is looking to raise US$3 billion in a Hong Kong IPO of Resourcehouse, which is developing iron ore and coal mines in Australia to supply steel mills and power companies in China. Another Australian company, Sino Gold Mining became the first foreign company to list on HKEx in 2007. It has since merged with Eldorado Gold (ELD-T, EGO-N) and delisted from HKEx on the completion of the merger in December 2009.

“There is indeed a trend developing,” says David Richardson, a partner at Dorsey & Whitney in Hong Kong who handled the HK listings of Sino Gold and South-Gobi and says he is working on a substantial number of listings of mining companies, one of which is from North America.

Richardson anticipates he will double the number of mining IPOs he is working on over the next 12 months and says he believes the majority of them are likely to come from the TSX, based on the sheer number of mining companies listed there. “There are some exciting ones coming up,” he confides. “I’m asked all the time to see the South-Gobi prospectus.”

One of the biggest advantages Hong Kong has is that stock markets in China remain closed to foreign mining companies. Says Richardson: “It will take at least five years for that to change and that’s a lifetime in this business.”

By definition all mining companies today, whether they have assets in China or not, are “China plays,” Richardson argues, because much of the metals that are produced worldwide are currently or will be in the future, sold to China.

Of the 1,300 companies listed in Hong Kong, just 160 of them are from the energy and natural resources sector. Their market capitalization is a fraction of the exchange’s total market capitalization of US$2.2 trillion. But energy and natural resource sector companies still account for about US$1 billion in daily turnover compared with a total of US$9 billion in daily turnover for the exchange as a whole.

Hong Kong started marketing itself to foreign companies about three years ago. It is also in the process of modifying listing rules for mining and natural resource companies to make it easier for companies in the sector to list in Hong Kong. The new rules are expected to come out in May or June this year.

“We visited Russia in early February and we were very, very well-received there and for the first time some of the state-owned companies showed an interest,” Arculli said. “Robert Friedland was very happy with the SouthGobi listing and on this trip to Canada, Ivanhoe helped organize meetings with other companies in their group in Vancouver. We met with other Canadian companies as well with market caps ranging from $10 million to $100 million.”

When it comes to the cost of listing, Arculli adds, Hong Kong isn’t off the charts. “The costs are higher than the TSX but if you look at overseas exchanges in general we’re pretty competitive. I can’t believe we’re more expensive than New York.”

Notes Chow of Latham and Watkins: “Hong Kong continues to be one of the top IPO markets in the world, which tells you that costs aren’t prohibitive.”

The HKEx boasts a diversified investor base, 62% of which is made up of institutional investors and 42% of overseas investors. Of the overseas investors, 36% come from the U.S., 23%
from the United Kingdom, and 26% from other countries in Asia.

Since 1999, the market capitalization of natural resources companies on the HKEx (85% of which have assets in China) has grown more than 30 times to US$336 billion, according to figures from Hong Kong Exchanges and Clearing.

Of course it’s not going to be a slam dunk for Hong Kong to attract the world’s mining companies. Banovich of Latham & Watkins’ Moscow office says he is not sure to what extent the trend will continue and argues it will be likely a destination for large caps in particular.

For Russian companies, he points out, a key advantage of a London listing is that there is a large and deep pool of investors who are accustomed to valuing Russian mining companies and are “relatively less likely to apply a deep discount to comparatively relaxed corporate governance standards and the uncertainties of the legal and economic environment.”

Banovich maintains that, although the Rusal case may in some ways be idiosyncratic, rising political tensions between Russia and the U.K. that peaked in 2007-2008, may have begun the process of weakening London’s erstwhile lock on Russian deal flow. “As tensions increased in 2007 and 2008, you started seeing companies that were close to the state, or partly state-owned, examining Germany or Hong Kong as possible venues.”

And while Banovich notes that Latham is currently working on another mining listing from Russia and believes there may be five or six more in the pipeline, one of the barriers that may keep Russian companies away from Hong Kong are its more stringent listing requirements and stock exchange scrutiny.

“Corporate governance and other listing standards are much more stringent, and more rigorously applied, in Hong Kong,” he explains. “By and large, Russian issuers tend to see listing or corporate governance standards through the prism of a cost-benefit analysis, and would not undertake greater compliance burdens then they absolutely have to in order to obtain the valuations they want to achieve.”

Says Banovich: “Will more companies go to Hong Kong? Probably. Will there be a sea change or major shift away from London to Hong Kong? That’s a question. It’s not clear to me that there will be.”

Companies that want to list in Hong Kong do have pretty high hoops to jump through, lawyers agree. Under proposed changes to the listing rules for mining companies, they will have to demonstrate that they have sufficient working capital to meet 125% of their budgeted working capital needs for the ensuing 12 months and if they are unable to meet the financial requirements the company would have to demonstrate that its management and board of directors have a minimum of five years experience in mining and exploration work.

Richardson of Dorsey & Whitney estimates that it typically takes between six to nine months to complete a listing as long as a company has everything organized and ready to go beforehand.

Looking ahead, Asia-based business reporter Shameen anticipates that some of the industry’s biggest players will turn to Hong Kong for secondary listings.

“The problem any investment banker working on large IPOs will tell you is that it’s really hard to raise cash in North America these days, certainly not at the sort of valuations you used to get some years ago,” he says.

“My bet is that big global miners like BHP Billiton (BHP-N), Rio Tinto (RTP-N, RIO-L), and possibly even Vale (VALE-N) will seek a secondary listing in Hong Kong within five years. Freeport-McMoRan Copper & Gold (FCX-N) is already thinking of Jakarta or Hong Kong and eventually the big Canadian mining firms will seek a secondary listing in Asia as well.”