Hong Kong: desperate times

Attempts to invigorate the IPO market with risky tech plays does not augur well, writes ACGA Head of Research Jane Moir.

On the same day Hong Kong’s Chief Executive John Lee announced plans to reverse an exodus of residents from the financial centre, the Stock Exchange unveiled a pathway for fledgling tech firms to IPO in the city. Neither seemed to excite the market, which closed 2.4% lower.

Both Hong Kong and the bourse are seeking to reverse their fortunes. Residents are heading for the door amid strict Covid-19 restrictions and political upheaval (see our blog on an executive exodus at the SFC), while thin IPO pickings and a trading slump are battering finances at Hong Kong Exchanges and Clearing (HKEX).

To mitigate their losses, the government and HKEX are lowering the bar on entry requirements. Mr Lee announced on 19 October 2022 that he will introduce a new visa programme to attract overseas talent. HKEX meanwhile intends to put down the welcome mat for “leading edge” tech firms via a new listing regime which slashes eligibility criteria, revenue being optional.

Both are tweaks, well shy of a road map. HKEX is carving out rules to fit a new segment of applicants, as it has done since 2018 when it lowered the bar for weighted voting right (WVR) stocks and biotech firms, followed by secondary listings and most depressingly, SPACs.

The net effect is a set of Listing Rules bereft of simplicity and certainty. Successive slicing and dicing, loosening and annexing has made room for issuers with a lower tolerance for governance, a higher appetite for waivers and the increased necessity of ‘case by case’ decisions and patchwork guidance. Both WVR listings and the proposed specialist tech regime rely on third party investment as a barometer of suitability. Listing in Hong Kong is today a very subjective affair.

All hail tech

The bourse is seeking to attract IPOs of “Specialist Technology Companies.” In a 172-page consultation paper, it describes a sizeable list of potential candidates, from manufacturers of electric vehicles and nanomaterials to makers of fake meat. HKEX aims to close a (very wide) gap between itself and the US, and Shanghai’s STAR market in wooing these listings.

To do so, eligibility thresholds will be significantly loosened for these firms to gain entry to the main board. Candidates with at least three years’ of operating history and ownership continuity of 12 months will be split into two categories: commercial companies with “meaningful” revenue; and pre-commercial ones at the research and development (R&D) stage who “present high growth potential” but have yet to generate significant revenue.

The commercial applicants will be expected to generate at least HK$8 billion in market capitalization at IPO with revenue of at least HK$250m for its most recent financial year. They will also have to show that R&D investment makes up 15% of its operating expenditure in the three years prior to listing. Pre-commercial companies present a higher risk and will need a higher expected market cap of HK$15 billion, and R&D investment of 50% of operating expenditure.

Risky business

The consultation adeptly sets out the hazards ahead, and it is a long list. Beyond the obvious question of how to value these companies, there is the risk of speculation and manipulation as the market punts on their chances of success; the potential pivot to new business models if Plan A doesn’t work out; the high likelihood of share price volatility or trading illiquidity post-IPO; the lack of a competent authority to judge a company’s progress in developing its products; the inability to test the veracity of claims being made by firms on their technical capabilities, commercial viability and ultimately, their products; the possibility they may never successfully commercialize their products; the lack of revenue to fund themselves leaves them reliant on equity or debt financing and at higher risk of corporate failure; and the possibility that to find extra funds, the firms will heavily dilute their shares after they float.

Among the 27 stakeholders the Exchange engaged with in a soft consultation (investment banks, private equity, potential listing candidates and the like) at least some (“a minority”) were wary of any retail participation in pre-commercial firms. Indeed, some doubted whether there was any appetite among institutional investors for such a risky play.

And already the Exchange has mooted widening the parameters of what would be considered “specialist,’’ opting for a broad definition within the Listing Rules which will be supplemented by a guidance letter with a non-exhaustive list, enabling “flexibility to update the guidance letter as Specialist Technology Industries evolve over time.’’

Money talks

The Exchange seeks to give investors extra comfort by relying on post IPO lock-up periods for shareholders, and third party investments by the ubiquitous “Sophisticated Investor.’’ At least two “pathfinder’’ sophisticated investors (funds, asset management firms, companies with large scale) will be required to invest ahead of an IPO at the rate of 10% to 25% of issued share capital, depending on the size and risk profile of the candidate.

This is not the first time the Exchange has relied on third parties as a proxy for suitability: it also did so in 2018 with WVR companies. As ACGA pointed out at the time, investment by a sophisticated investor only means they hoped to make money, not that a R&D product is a suitable investment for others.

Place your bets

The Listing Committee has its work cut out for it: if the plan goes ahead, it faces a list of highly speculative tech stocks, some of whom may have a WVR shareholding structure, perhaps seeking to de-SPAC. Decision-making will be highly intuitive: is a WVR stock truly innovative, will a “leading edge” tech firm be suitably special? The stock exchange has limited sanctioning powers, and investors little recourse, if things go south.

Without a doubt, the consultation missed the mark on timing. The prospect of zero-revenue tech firms with a novel product may have been a hotter ticket 18 months ago. Today, investors are sucking up a 50% drop in the Hang Seng Tech Index over the past twelve. In such uncertain times, perhaps the market would see greater value in setting the bar higher.