Hong Kong’s relatively new practise of allowing retail investors to enter bids for less than the floor price in initial public offerings (IPO) has attracted investors who have become more flexible with their bets. The low-ball bid can be a risky strategy because there is no guarantee that an IPO will proceed smoothly and achieve the full target allotment. It also does not come without a cost: Issuers take a substantial discount, while retail investors get a slot in the deal at a lower price point.
One thing is sure, though – it works, at least for now! We have seen hundreds of applications through this method since Hong Kong Exchanges & Clearing launched its Retail Share Offering Program. Overall demand has been so overwhelming that issuers have jacked up their targeted size in five out of nine deals since the program was initiated.
It’s an exciting development because it signals a shift toward greater flexibility among institutional investors who use this mechanism to widen their bid-ask spread and place bets on price movements. Some people might view it negatively for issuers, but they want to tap into hot money anyway.
By widening the bid-ask spread, investors can differentiate themselves from other buyers or sellers in an illiquid market. For example, if there are only two bidders – one at HK$6 per share and another at HK$5 per share – the former will be able to sell its stake at a higher price. As a result, institutional investors have been taking advantage of this “gap” in pricing by submitting bids below the floor price for Hong Kong IPOs since the option became available last July.
One thing that might worry retail investors is that a large portion of IPO applications from these big institutions is under HK$1 per share. They can easily buy up all shares allotted to them and dump their stakes on the market during the first few days of trading, rendering prices vulnerable to demand shocks. Most retail applicants seek to pay as little as possible for their allotment, narrowing the gap between institutional bids and offers.
With many retail investors unwilling to pay more than the “winning bid”, the resulting low-ball bids provide buy-side institutions with a larger play area to take advantage of gaps between the floor price and market prices. It might come as bad news for retail investors. However, they still have plenty of room in IPOs where institutional demand is capped at a predetermined percentage per the required allotment formula.
Retail applications are bounded by the required allotment ratio that caps institutional demand at HK$1 billion, so there is no way they can outbid retail investors. Institutional bidders use this mechanism to broaden their bid-ask spread when they face little competition from individual investors, which has driven up the targeted size in seven out of nine deals since July.
A new product was launched a few years ago due to an under subscription of retail applications during two initial public offerings (IPOs). The “low-ball bid” mechanism allows institutional investors to apply for shares at prices lower than the reference price set by issuers, even if there is no competition from retail investors. Therefore, more flexibility will reduce the risk premium bidders have attached to their bids since this mechanism began being used until March 31, 2013, with almost 500 applications with an average size of fewer than two times the required allotment ratio. Institutional investors could be buying stocks from retail investors, though their risk appetite remains unknown.
* The reference price is a price set by the issuer for its shares before an IPO to indicate the maximum price at which shares may be sold via this mechanism. As IPOs are conducted through book-building, they are considered privately placed securities. Therefore, it’s not possible to place bids below floor price in Hong Kong IPOs unless there is no competition from retail investors. Navigate to this website for more information.