This article first appeared in The Edge Malaysia Weekly on July 17, 2017 - July 23, 2017

THE relisting of Lotte Chemical Titan Holdings Bhd (LCT) could have been a comeback tale. Instead, there was a cloud of doubt and scepticism in the foyer of Bursa Malaysia last Tuesday morning as LCT’s shares began to fall moments after the gong was struck.

The petrochemical group’s share price closed 1.4% lower at RM6.41 last Friday, even with the company snapping up 23.4 million shares to stabilise the price over the week.

Clearly, the 22% downsizing of the offering to 580 million shares and the repricing at RM6.50 per share (from initial expectations of RM8) was to blame.

But despite the negative sentiment, the entire exercise was far from a disaster.

Not only was the deal salvaged, but it also managed to keep to its original timetable. If anything, it showcases the hard work and quick thinking of the investment bankers involved, as well as the flexibility and robustness of the country’s regulatory framework.

In fact, bankers involved in the deal argue that all stakeholders enjoyed positive outcomes from the exercise. At the very least, there were no negative implications from the downsizing and repricing of the initial public offering.

That said, the unusual path LTC took to listing certainly demands closer examination — what were the circumstances that created this perfect storm? How did the IPO’s arrangers and promoters negotiate such a swift solution? What are the implications for future listings?

Speaking to bankers, regulators and fund managers, The Edge takes a closer look at LCT’s peculiar listing.

What went wrong?

Short answer: Lack of foreign interest in the IPO, and an absolute share price that was too high.

Long answer: The foreign investment banks advising on the deal appear to have grossly misjudged foreign institutional interest for LCT’s offering.

One banker familiar with the deal says foreign institutions were initially expected to take up almost 50% of the offering, or almost RM2.95 billion of the RM5.9 billion worth of shares offered (at the initial estimate of RM8 per share).

But when it came to the actual book building in late June, most of the foreign “long funds” — funds that take long positions — showed little interest in the placement.

Ultimately, foreign institutional investors would take up only 20% of the downsized institutional offering — RM710 million worth of shares.

That means the global coordinators and joint bookrunners, Credit Suisse and JP Morgan, had overestimated foreign appetite for LCT by a whopping RM2.24 billion.

At the same time, the book-building failed to get off the ground with the retail portion of 55.783 million shares undersubscribed by 38%.

This has largely been blamed on the uncharacteristically high absolute share price of the IPO.

“Of course, institutional investors don’t care about absolute share price. They look at the valuation. But for retail investors, this could be a deterrent. And when you go for a listing this size, you definitely don’t want to alienate any potential investors,” notes another banker.

It is understood that some bankers even pushed for a share split that would have brought the share price down to the RM2 to RM3 range.

However, there is a simpler explanation — the offering was simply too big for this kind of stock.

At the prospective RM8 per share, arrangers would have aimed to raise nearly RM446.26 million from retail investors. Based on RM6.50 per share, only RM224 million was raised from retailers, but that figure will fall as many are expected to accept the company’s buyback offer.

“This is not a stock that retail investors typically prefer. Just look at Petronas Chemicals Bhd. It is heavily institutionalised and boring for retail investors. That LCT got as many retail subscriptions as it did is considered pretty good,” the banker adds.

Keep in mind that with sufficient institutional interest, retail undersubscription would not be an issue due to the clawback and reallocation provisions that allow funds to take up the unsubscribed retail shares.

Was the offering too ambitious?

Short answer: It was too big for the current market.

Long answer: LCT’s listing was seen as major test for the country’s capital market after two lacklustre years.

It is interesting to note that LCT has an incredibly strong balance sheet — with RM1.04 billion in cash and virtually no borrowings. There was no immediate urgency for the IPO, at least one to raise a whopping RM5.9 billion. Around 83% of the proceeds was slated for the construction of a new petrochemical facility in Indonesia over the next three years.

A more conservative approach would have been to stagger the fundraising in two rounds. Many smaller and more cautious IPOs in recent years have taken this route — following up a relatively small IPO with a rights issue or private placement one or two years down the road.

In fact, the downsizing of LCT’s IPO proves that this was a viable option all along.

Nonetheless, some bankers believe the initial sizing and pricing of the offering were not ambitious, given the information at the time.

“Remember, we had the cornerstones come in at RM8. In fact, some had even indicated that they were happy to pay as much as RM8.60. Furthermore, there was no indication that there would be such a poor turnout by foreign funds at the time,” explains the first banker.

He points out that larger IPOs for similar types of companies have been done in the past. Petronas Chemicals managed to raise a record RM12.89 billion in 2010.

“Of course, LCT does not have a parent like Petroliam Nasional Bhd. But it was raising less than half that amount and priced at a discount to PetChem. The size and pricing of the offering was not unreasonable,” he argues.

Who paid the price?

Short answer: Perhaps the investment banks and the promoters, but only very little.

Long answer: At face value, almost all stakeholders emerged with positive outcomes from the IPO. Sure, LCT would have liked to have raised more money but, objectively, no one party appears to have been hurt. In fact, an SC spokesperson points out that the transaction actually demonstrates the sophistication and flexibility of Malaysia’s IPO framework in responding rapidly to market needs without compromising investor protection.

After all, retail investors (and bumiputera investors approved by the Ministry of International Trade and Industry) got a pretty good deal — a risk-free option to exit at RM6.50. Furthermore, they have the opportunity to observe the post-listing share price until July 18 before deciding. Had the share price improved after listing, retailers would have enjoyed the upside.

As for the institutional investors, many were willing to pay RM7.60 to RM8 per share in the first book building. Now, they enjoy a cheaper entry into the stock. Furthermore, they were not forced to participate in the second book building.

In addition, the stabilisation action provides an avenue for funds to exit over the first 30 days (or up to 27 million shares).

Meanwhile, the investment banks will have to settle for a smaller placement and underwriting fee due to the downsizing of the exercise. Based on the 1.5% fee, and the downsizing of the IPO by RM2.13 billion, the investment banks would lose out on approximately RM32 million worth of fees.

In contrast, the total listing expenses were estimated at RM152.9 million.

However, this is a small price to pay.

“Had the banks been forced to underwrite the shortfall, we might have had to subscribe for at least US$100 million to US$150 million (RM645 million) worth of shares. The six banks could have taken it on, but it would have been bad for the after-market performance of the shares. The banks would look to get rid of the shares and investors do not like this,” explains the first banker.

Last but not least, LCT itself should not be too displeased by the outcome. Given the lack of foreign interest in the IPO, it is commendable that the deal was still closed, carried primarily by domestic funds.

Even though it was downsized to RM3.77 billion, LCT’s listing is still the largest in the region in recent years.

What are the implications?

Short answer: LCT’s listing is unprecedented but unlikely to make future IPOs easier.

Long answer: LCT’s path to listing was certainly unconventional and it put the regulator’s flexibility to the test.

Despite the massive changes made to the IPO, it did not trigger Section 238 of the Capital Markets and  Services Act, which would have required the filing of a supplementary prospectus.

This would certainly have delayed the listing. And an extended delay would have risked scuttling the entire exercise.

However, the circumstances surrounding LCT’s listing were unique. It is highly unlikely that future IPOs will be able to pull off a similar stunt.

This is largely due to the nature of LCT’s business, as well as its healthy balance sheet and cash flow, which gave the company room to manoeuvre when the IPO was downsized.

It is understood that Article 238 was not triggered for two key reasons.

First, and most crucially, the banks were able to show that the downsized IPO would not materially derail LCT’s business and its expansion plans. The group convinced regulators that it could still build its Indonesian plant regardless of the smaller IPO.

Secondly, the change in size would not adversely affect the voting power of the shareholders. In fact, a smaller issuance increases the voting power of each share.

The banks were also able to prove to the SC that institutional interest in the offering was still healthy. After all, many were already prepared to pay as much as RM8 a share. At RM6.50, many were eager to close the deal. This gave the regulator confidence in the viability of the resized deal, explained the second banker.

Thus, while LCT’s IPO certainly sets a precedent, it has not pioneered a new way for companies to approach an IPO.

“They can’t just mess up their roadshows and book building and run to the SC for help,” one veteran industry player tells The Edge.

If any precedent is being set, it is that the SC is applying and interpreting the laws in a more market savvy manner — ensuring transactions can be facilitated despite adverse market events.

In the case of LCT’s listing, the SC did not apply the law in a rigid manner. Instead,  a lawyer points out that the SC examined the facts thoroughly, gave it careful thought, and then applied the law in a more judicious manner.

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