October 3, 2011 / 1:50 AM / 6 years ago

RPT- DEALTALK-Demise of China's XCMG deal exposes rifts, rivalries

(Repeats story issued late Friday with no changes to text)

* XCMG deal collapsed as banks fled hard underwriting commitments

* Booming business of China IPOs filled with pitfalls, surprises

* Failed deal exposes intense competition between Chinese, global banks

By Elzio Barreto and Fiona Lau

HONG KONG, Sept 30 (Reuters) - The failed $1.5 billion Hong Kong public offering of China’s XCMG Construction Machinery exposed a lot more than a fragile stock market.

A look at what went on behind the scenes in the deal’s final days shows just how complex and competitive it is getting to execute a capital markets offering for a Chinese company.

The offering also shines a light on a touchy subject in the investment banking world, a term the industry knows as “hard underwriting,” whereby a bank backs a stock offering with its own money.

That term has put more conservative foreign banks and Chinese underwriters at odds, as was the case with XCMG.

“Compared to well-established international banks, we are infants. We need to have a strong selling point to compete with them,” said one Chinese banker, who declined to be identified because of the sensitivity of the subject.

“It’s like when you open a new store, you will offer discounts to attract customers. What we are offering now is a commitment to help companies finish their deals, even in a bad market.”

The hard underwriting issue, combined with a plunging Hong Kong stock market, a desperate bid to rescue the offer, and an overcrowded lineup of Chinese and foreign banks, paved the way for an ugly end to the deal.

At the last minute, XCMG doubled the underwriter list to a whopping 12 banks, a rare move given a deal of that size. Five of the six banks added were Chinese, while the original list was mostly of foreign banks.

XCMG then cut the deal size from $1.5 billion to $1.2 billion, offering a deep discount to lure investors.

What bankers involved with the transaction said was the most frustrating part was a communication breakdown by the company -- centered around hard underwriting -- that caused finger pointing and anger among the banks and executives involved.

The two-day roller coaster ride that XCMG underwriters went through last week shows that while bringing China’s companies public is a booming business, the headaches and surprises that emerge can be substantial.

The XCMG saga also shows the extent to which banks, despite these complications, are willing to go through to take on fast-growing Chinese companies. The future business and fee potential they bring can be massive, outweighing the grief that can occur along the way.

XCMG and the banks mentioned in the story declined to comment.


Earlier last week as market turmoil forced bigger rival Sany Heavy Industry Co Ltd to postpone a Hong Kong $3.3 billion offer, XCMG sensed that the only way to save its deal was to get a hard-underwriting commitment from the banks to buy any unsold shares in the offering.

So the company asked the new banks, which included Goldman Sachs and several Chinese firms such as ICBC , to take that risk and commit to buy at least half the offer, or provide about $600 million of their own funds to back the deal, according to bankers involved with the transaction.

Most of the new banks agreed, on the impression that the original six had also agreed to a hard-underwrite.

Soon after some of the new banks committed, they learned that the original banks had no intention of backing the deal with their own money. At least one of the bankers involved believed the miscommunication was not exactly an accident.

When word about the misunderstanding spread, banks began to back out of the deal. The transaction soon collapsed.


XCMG originally hired a team consisting mostly of global investment banks including Credit Suisse , HSBC and Morgan Stanley .

That group warned the company that there was a slim chance of the deal getting through with the Hong Kong stock market enduring its worst quarter in a decade, according to people directly involved in the discussions.

But the company believed it could do it and added six more banks, including Chinese giants ABC International, BOC International and ICBC International.

The newly assembled team was more encouraging, with most agreeing to hard underwrite part of the offering at the company’s request.

ICBC International had agreed to commit $300 million to the deal, sources familiar with the matter said. In return for their commitment, the Chinese banks wanted a greater say in determining the price range, sources said.

When the new banks realized that the others were not hard underwriting, the finger pointing began. One source involved said that XCMG and some of the Chinese banks accused the foreign banks of not being committed enough to the deal.

“The issuer blamed the foreign banks for their inability to sell the shares, as well as for their refusal to hard underwrite the deal. It questioned the value foreign banks can bring to the deal if they continued to handle the offering,” the source said.


Chinese banks have become more aggressive in their pursuit of underwriting Hong Kong deals, a space dominated by international banks.

In addition to top investment bank CICC, Guosen Securities, Citic Securities and PingAn Securities Co Ltd dominate the Chinese market, with UBS and Deutsche Bank’s Zhong De Securities Co joint venture as the top-ranked overseas stock underwriters in China, this year.

“For newcomers to break into the market, they need to offer something that more than compensates for their shortcomings in other areas,” said one foreign banker, referring to hard underwriting.

Chinese banks’ hard underwriting bids have long irked international banks, which are more hesitant given their tight capital requirements and the risky nature of the transaction.

Chinese banks defend their tactics as being reasonable and even necessary, arguing that it’s the only way they can gain some kind of advantage to raise their profile and market share.

“We don’t really have a choice here,” said another banker at a Chinese bank. “It’s not only about competition between foreign and Chinese banks. There is also keen competition among Chinese banks. When your competitors take out their checkbook, we can only follow.”

A typical example of Chinese banks winning repeat business through hard underwriting is the HK$1.75 billion ($225 million) Hong Kong IPO of Newton Resources in June.

The institutional tranche of the deal was only 81.3 percent covered. BoCom International, one of the bookrunners, rescued the transaction by taking up the remaining 168 million shares, or 18.7 percent of the deal, according to a securities filing.

As of September 29, shares of Newton closed at HK$0.96, 45 percent below its offer price of HK$1.75. Although suffering a paper loss, BoCom International has in return been given a role in the $3 billion to $4 billion Hong Kong IPO of jeweller Chow Tai Fook, owned by Hong Kong tycoon Cheng Yu-tung who controls Newton through his company New World Development , according to a source involved in the transaction.

For the international banks, Chinese firms have very limited ability to successfully underwrite many of the larger deals because they don’t have global distribution channels.

“Right now we’re seeing this increasingly as a competitive tool that the domestic Chinese banks are using to insert themselves in the transactions,” said another source at a global bank involved in the XCMG offer.

“But there have been several occasions when this has been tested and pushed, and the actual hard underwriting falls apart, and they pull back the commitment,” the source added. ($1 = 7.795 Hong Kong Dollars) (Editing by Denny Thomas and Michael Flaherty)

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