A sleepy fishing village just three decades ago, the southern Chinese city of Shenzhen last year hosted more IPOs than New York, Hong Kong and London combined - averaging one each business day, and unleashing a gush of fees for bankers, lawyers and advisers.
As equity capital markets have cooled across Asia, the bustle and high fees in a market just an hour's train ride from Hong Kong make Shenzhen one of the biggest untapped opportunities for global banks. While the fees are tempting for those Wall Street and European bankers who have derided Shenzhen as a Wild West venue for small, untested firms listing at sky-high prices, it's the local banks and brokers leveraging their Chinese credentials that have reaped the benefits.
It's hard, really hard. It's a local market for local market participants, said one equity capital markets banker at a global investment bank, who didn't want to be named as he was not authorized to speak publicly on the matter.
That may be about to change.
China has unveiled measures to spend $45 billion to create a mini-Hong Kong financial hub in Shenzhen's Qianhai Bay, leading a drive to internationalize the yuan currency, deepen ties with Hong Kong and ultimately establish a financial market on a par with New York or London.
Dan Weil, a 36-year-old American and Hong Kong-based global head of institutional sales and trading at one of China's oldest brokerages, Guosen Securities, said the Chinese have historically struggled to make the most of their financial strengths and local reach, but are now more competitive.
For Chinese firms, our competitive advantage is obvious; this is our turf, our home, we know China, we have deep roots, we have lots of employees. For the biggest of the big, scale matters, he said.
WORLD'S IPO CAPITAL
Companies last year raised about $26 billion in IPOs on Shenzhen's Small & Medium Enterprise (SME) board and on ChiNext, its Nasdaq-style start-up market - more than double the new listings on Nasdaq and two-thirds more than London, Thomson Reuters data show. New York IPOs raised $31 billion, and Hong Kong $23 billion. Shenzhen boasted 236 IPOs, while New York ranked second with just 69.
That trend has continued this year, with 84 IPOs in Shenzhen in January-June versus 44 in New York.
Riding the Shenzhen wave, Chinese securities firms earned more in estimated underwriting fees last year than the likes of Goldman Sachs (GS.N) and UBS (UBSN.VX), which cover all of Asia Pacific, data show. Ping An Securities earned $232 million in fees, and Guosen Securities $215 million. Half of the top-20 fee earners in Asia ex-Japan were securities firms from China.
And that fee gap has widened, with Guosen netting $99 million and Citic Securities (600030.SS)(6030.HK) $97 million in January-June, well above Goldman's $63 million in estimated fees, according to Thomson Reuters/Freeman Consulting. While UBS topped the first-half estimated fee league table, Chinese firms took three of the top five slots.
Despite the obvious earnings potential, Western banks have steered clear of Shenzhen's lofty stock valuations and the possibility of a bubble pop. The reputational risk for taking public a company with potential accounting issues is also not insignificant, bankers said.
Some of these companies don't necessarily have the track record of the main board Shanghai-listed companies. It costs the same to do due diligence in a $50 million deal as in a $5 billion IPO, the ECM banker said.
Illustrating the potential pitfalls, UBS, the top stock underwriter in Asia Pacific for six of the past seven years, was canned in the local media over two deals it worked on last year - a Shenzhen offering by BYD Co Ltd 002594.SZ(1211.HK), the Chinese car maker backed by billionaire investor Warren Buffett, and a Shanghai IPO by auto distributor Pang Da Automobile Trade Co Ltd (601258.SS). Shares of both companies tumbled after listing.
FROM FISH TO FINANCE
A small coastal village of just 30,000 people, Shenzhen exploded soon after 1979 when Deng Xiaoping named it among the Special Economic Zones set up to foster a new breed of development in China. It has grown to a metropolis of more than 14 million people with skyscrapers, a modern subway, glitzy malls and factories making everything from iPhones and high definition TVs to fake watches and plastic toys.
Shenzhen had no stock exchange until 1990, with activity taking off after the SME and ChiNext boards were launched. The number of listed companies has almost trebled from about 500 before the SME board started eight years ago, and the market value of listed companies soared to $1.2 trillion at end-May.
That's still a lot less than the New York Stock Exchange's $12.5 trillion, but double the size of Singapore's exchange.
Companies on the Shenzhen Exchange trade at an average 23 times their earnings, down from a frothy 2008 peak of 76 times. The price-to-earnings ratio - a measure of future earnings growth - has tumbled to about 39 times from a 2009 high of 128 for companies on the ChiNext board.
JUST GO UP
At a retail branch of Guosen Securities in Shenzhen, Liang Cheng sits in a cubicle at a computer, poring over charts, stock prices and financial statements in a dimly lit trading room that feels more like an Internet cafe than a brokerage. Liang, in her twenties, is one of an army of investors who in a few short years have turned the Shenzhen Stock Exchange from an obscure outpost to the world's busiest IPO market.
You really need to be careful what you're buying now, she said. Previously, everything would just go up.
Her assessment of the exchange's risk is an understatement.
The local stock index .SZSA is down by 21 percent in the past year, with the index chart looking like shark's teeth, with sharp gains and sharper falls - making it easy fodder for those who say Shenzhen is more a casino than a stock market.
Regulators have taken notice and are moving to bolster confidence in a market where the more than 72 million Chinese retail investors account for nearly three-quarters of trading volume. Tougher rules - making it cheaper to trade shares, easier to de-list underperforming companies and forcing greater disclosure [ID:nL3E8FA3NA] - could chill new listings, but help increase deal volumes and fees as sentiment improves long-term.
The Shenzhen bourse is also setting up a joint venture with Hong Kong Exchanges Clearing Ltd (0383.HK) and the Shanghai Stock Exchange to develop financial products and services and boost competitiveness as markets become increasingly global.
Global banks including Goldman, UBS, Credit Suisse (CSGN.VX) and Deutsche Bank (DBKGn.DE), already in China through joint ventures, have focused on multi-billion dollar IPOs of state-owned enterprises and large offerings in Shanghai. But, with most big privatizations now done, growth will come from entrepreneurs taking their small businesses public.
A batch of global banks were approved to set up shop in China last year, including Morgan Stanley (MS.N), Citigroup, Royal Bank of Scotland (RBS.L) and JPMorgan (JPM.N), allowing them to underwrite and sponsor stock and bond offerings and offer advisory and investment banking products.
Jerry Lou, head of global capital markets and chief strategist for Morgan Stanley Huaxin Securities, the local venture, said small- and medium-sized businesses, which have been relatively undercapitalized compared to the state-owned sectors, are leading the charge for capital.
Lou said the venture, based in Shanghai, would work on Shenzhen IPOs this year, though he gave no specifics. There will be ups and downs, but in terms of the absolute potential for the market to further grow, I could see this market doubling or tripling in the coming 5-10 years.
But it will be tough for foreign banks to wrestle market share from entrenched local rivals such as Guosen, Citic, PingAn Securities and Huatai Securities (601688.SS). Citic has for years had separate teams focusing just on smaller listings in Shenzhen, and Guosen has an army of 475 bankers in mainland China to originate new deals.
Wang Chang Hong, head of equity capital markets at Citic Securities International, predicts tougher competition as foreign banks switch on to the Shenzhen story, but believes Chinese firms will respond to that threat. The competition will force us to improve. Probably they will eat into our market share a bit. But in the end, the local players will win out, so long as they're willing to adapt, willing to improve.
For Guosen's Weil, home advantage is key for the Chinese firms.
Shenzhen is no longer just the gateway to Hong Kong. It's wealthy and there's a lot of money parked there. There's a lot of high net worth and corporations basing themselves in the greater Pearl River delta.
I looked at the opportunities in town and to me it was a no-brainer; to find the right Chinese firm where I could put in place best practices and help build something. That's my single biggest competitive advantage. I have massive reach into China at a low cost, and that reach is valuable.