FINANCE – HK-Shanghai Link Could Spark Brokerage Tie-Ups
Bottom line: The latest M&A in China’s brokerage sector involving Essence Securities could presage a new wave of tie-ups between Chinese and foreign brokerages, boosted by the Hong Kong-Shanghai stock exchange link.
A new reverse takeover involving a major Chinese brokerage is shining a spotlight on the potential for new deals in the sector following this week’s launch of a ground-breaking program linking the Hong Kong and Shanghai stock exchanges. This particular deal involves Essence Securities, which is becoming a publicly traded company following its purchase by Shanghai-listed textile firm Sinotex Investment (Shanghai: 600061). But more intriguing is the very real possibility that major foreign brokerages may start to look for tie-up opportunities with Chinese peers in anticipation of synergistic partnerships to take advantage of the new Hong Kong-Shanghai Connect program.
The Connect program got off to a relatively low-key start on Monday, but looks full of potential by making Hong Kong stocks available to Chinese investors and vice versa. The resulting big flow of foreign money into Chinese stocks, and Chinese money into Hong Kong shares, means many of the foreign brokerages with offices in Hong Kong may start to look for Chinese partners to facilitate their cross-border business.
Some similar tie-ups occurred more than a decade ago, when Hong Kong’s emergence as a new listing ground for many Chinese companies prompted off-shore brokerages to buy a number of local peers. Such cross-border tie-ups would also be consistent with a broader effort by Beijing to consolidate the nation’s fragmented brokerage industry.
But that said, many of China’s top brokerages also have limited attraction due to their poor management, limited business scope and China’s tough rules regarding foreign investment in the country’s financial services sector. Accordingly, the most I would expect in a coming wave of cross-border tie-ups would be purchases of minority strategic stakes in Chinese brokerages by some of their major off-shore peers.
All that said, let’s take a closer look at the latest deal that will see Sinotex purchase Essence Securities for 18.3 billion yuan ($3 billion), in what reports are calling a reverse merger. (English article) That’s because in this case, the deal would essentially transform Sinotex shares from a play in the stodgy textiles sector a more exciting securities play. Investors certainly liked the deal, with Sinotex shares soaring by their daily 10 percent limit when trading resumed on Tuesday after an earlier suspension.
The deal marks the latest sign of consolidation in China’s brokerage industry, which isn’t particularly profitable due to its strong dependence on fees from stock sales for much of its income. In July, Shenyin & Wanguo Securities agreed to buy Hong Yuan Securities (Shenzhen: 000652) in a stock deal valued at 39.6 billion yuan, creating the nation’s fifth largest brokerage. Founder Securities (Shanghai: 601901) was also approved in August to buy smaller rival China Minzu Securities.
A number of Hong Kong-listed Chinese securities firms look like the most obvious potential tie-up partners for foreign brokerages, including names like Haitong Securities (HKEx: 6837) and Galaxy Securities (HKEx: 6881). There’s also industry leader Citic Securities (HKEx: 6030; Shanghai: 600030), which is listed in both Hong Kong and Shanghai, and made its own recent M&A headlines earlier this year with a deal to purchase a stake in mid-sized US brokerage BTIG. (previous post)
Investors seem to be excited about the potential for Galaxy, whose shares nearly doubled after the Hong Kong-Shanghai Connect program was first announced before recently giving back some of their gains. Haitong shares have staged a similar rally, including a recent pull-back as excitement cools over the new stock exchange connection.
Despite their enthusiasm about China and the new Connect program, the western brokerages are likely to be quite careful if and when they choose Chinese partners. That’s because many big western names previously set up related fund-management joint ventures with Chinese partners, most of which were disappointments due to numerous restrictions placed on their operations.
But Beijing has shown more recent signs of relaxing many of those restrictions as it looks to create a financial services sector that can compete with better-run global rivals. That means we could soon see the big western and Asian firms exploring tie-ups with Chinese partners, and I would expect we could see at least one or two major deals in the year ahead, potentially involving minority stake sales.
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