Goldman Sachs Group Inc., the first Wall Street firm to win an underwriting license in China, is sitting out the world’s busiest initial public offering market.
The bank, No. 3 globally in advising on IPOs this year, has managed only one offering in China in three years, according to data compiled by Bloomberg, and three since it obtained its license in 2004. Goldman Sachs executives say that’s because they want to avoid the risk of underwriting unproven companies, face regulatory hurdles and have fewer employees than competitors. Instead, they’re taking Chinese firms public on overseas exchanges, where fees can be higher.
“You’ve got to be selective deciding how to allocate your resources,” said Cai Jinyong, 52, who heads Goldman Sachs’s investment-banking business in China and is CEO of joint venture Goldman Sachs Gao Hua Securities Co. “We focus on clients who have the potential to be a leader or already are leaders. We need to sell quality companies to investors.”
By forgoing deals on the Shanghai and Shenzhen exchanges, the bank is missing out on a fee pool that ballooned to $2.1 billion last year from $404 million five years earlier, according to New York-based consulting firm Freeman & Co. IPO commissions in China were $1.7 billion this year through early December, about the same as New York, more than a quarter of the world’s total, Freeman data show. Overseas listings of Chinese companies generated $399 million in the same period.
Analysts at New York-based Goldman Sachs have forecast that the value of firms trading on Chinese bourses will swell to $41 trillion in 2030, surpassing the U.S. as the world’s largest equity market. Shenzhen, the smaller of China’s two exchanges, is the busiest IPO market in the world by number of deals, with 222 new listings this year, Bloomberg data show.
Chinese companies raised $72 billion in domestic initial stock offerings in 2010, the most anywhere, and have sold $40 billion of shares so far this year, second only to the U.S., with $44 billion, Bloomberg data show.
“You just can’t afford losing out there,” said Josef Schuster, founder of Chicago-based IPOX Schuster LLC, which oversees $2.5 billion and invests in IPOs. “Mainland China has the most active IPO market in the world, and behind the closed doors, every bank is trying to get involved.”
Goldman Sachs executives say the firm can be a player in China without leading in the local IPO market. It is seizing opportunities in less risky areas such as institutional brokerage and advising wealthy Chinese clients, they say.
The firm also is focused on expanding its business of making investments with the company’s money. The firm’s stake in Industrial & Commercial Bank of China Ltd., the world’s biggest bank by market value, has generated $2.4 billion in revenue for Goldman Sachs since the purchase in 2006.
“We always take a gradual approach,” said David Ryan, 42, president of Goldman Sachs in the Asia-Pacific region, excluding Japan, and regional head of investment banking. “Given the challenges of finding the right people and getting them trained and integrated, we have to be very targeted using our limited resources rather than trying to pursue every piece of business.”
Goldman Sachs executives say they’re working on 30 domestic Chinese offerings, including some awaiting regulatory approval, which would raise about $40 billion.
The firm is ranked second globally in helping Chinese companies sell shares overseas this year, the same as last year, its best showing since 2006, according to Bloomberg data. Goldman Sachs has listed 45 Chinese firms abroad since December 2004 -- 17 in New York and 28 in Hong Kong -- the data show.
By bringing a Chinese share offering to a New York exchange, an investment bank can earn about 7 percent of total funds raised compared with fees averaging 2 to 3 percent in Shanghai, according to two bankers working on such deals.
Hong Kong’s IPO market, after years of growth, is becoming less profitable for investment banks. Total fees have fallen to less than a third of those in China or New York, according to Freeman data, as a record number of underwriters vie for fees.
Chief Executive Officer Lloyd C. Blankfein said at an investors’ conference in New York last month that China offered a “set of opportunities” unavailable 15 years ago.
Those opportunities also pose risks. The credibility of foreign investment banks may suffer if the performance of stocks they underwrite is lackluster said Jessica Lo, a Shanghai-based managing director at China Market Research Group.
Backing firms later accused of accounting fraud can also damage an investment bank’s reputation. China’s National Audit Office said on May that 17 state-owned companies, including publicly listed China Southern Power Grid Co., had misreported financial data. Private companies have also been investigated and their executives prosecuted.
Still, being too picky and missing out on mainland IPOs could jeopardize the firm’s ambitions in the country, Lo said.
“It’s a misguided strategy for Goldman to neglect the smaller Chinese firms,” she said. “There is so much fraud in the marketplace. That doesn’t mean you are scared of the market. You have to have the resources to do due diligence.”
Goldman Sachs says it has about 80 bankers in Beijing and 20 in Hong Kong dedicated to mainland China, more than double the total in 2009. China International Capital Corp., known as CICC, the biggest equity underwriter of Chinese companies, has about 400 bankers, according to the firm. UBS AG, the top foreign underwriter in China, has about 150 staff, with 100 dedicated to the domestic business, an official at the Zurich- based bank said.
UBS has underwritten 13 domestic IPOs since obtaining its license in late 2006. Eight are trading below their offering prices, with China Shipping Container Lines Co. the worst performer, down 59 percent since its 2007 listing. The Swiss bank was criticized in September by Shanghai Securities News, controlled by China’s official Xinhua News Agency, for failing to disclose “performance risks” when underwriting shares of Pang Da Automobile Trade Co. and automaker BYD Co.
Shares of Pang Da, based in Tangshan, have fallen 57 percent since its April listing. While BYD, based in Shenzhen, reported an 89 percent drop in profit for the first half of this year, its third-quarter profit rose more than sixfold.
Joanna Sin, a spokeswoman for UBS, said in September that the firm has been “diligently” fulfilling its responsibilities as an IPO sponsor. She declined further comment.
Of the three Chinese IPOs arranged by Goldman Sachs, only China Merchants Securities Co., a Shenzhen brokerage, is trading below its offering price, down 53 percent since November 2009.
‘Choose Your Spot’
Goldman Sachs has a 1.2 percent market share in the domestic Chinese equity and equity-linked markets this year, compared with UBS’s 6.1 percent, data compiled by Bloomberg show. The largest player is China’s Ping An Insurance Group Co., with 8.8 percent.
“You have to choose your spot in China -- it’s just too big,” said Jonathan Penkin, 47, Hong Kong-based co-head of equity capital markets for Goldman Sachs in Asia. “We have to work hard to protect the franchise.”
Goldman Sachs’s reputation in China took a hit in 2010 when the U.S. Securities and Exchange Commission said it misled investors on subprime mortgage products. That year, Chinese financial journalist Li Delin published “Goldman Sachs Conspiracy,” which said the investment bank benefited from the economic crisis and was out to destroy China.
“The book has been extremely popular in China,” said Lo.
Not Without Risks
Not all of Goldman Sachs’s listings of Chinese companies in the U.S. have come without risks. Longtop Financial Technologies, a Chinese maker of financial software, taken public by Goldman Sachs and Deutsche Bank AG in 2007, was delisted by the New York Stock Exchange in August.
Goldman Sachs set up shop in China in 2004 by teaming up with Fang Fenglei, a co-founder of CICC. Goldman lent Fang money to set up Beijing Gao Hua Securities. The companies then established the joint venture, Goldman Sachs Gao Hua Securities, of which Goldman Sachs owns a third. Goldman Sachs controls Beijing Gao Hua through undisclosed contractual arrangements. Fang is chairman of both Chinese entities.
The joint venture last year reported revenue of 824 million yuan ($129 million), including 67 million yuan from domestic underwriting, according to its annual report.
Caution in China
Goldman Sachs got its underwriting license two years before China put a moratorium on new joint ventures that kept many foreign rivals at bay. Since the ban was lifted in 2008, JPMorgan Chase & Co., Morgan Stanley, Credit Suisse Group AG and Deutsche Bank AG, have started operating their own ventures. Bank of America Corp. is the only major Wall Street firm that doesn’t have a license.
Goldman Sachs’s caution in China is reflected by its decision to drop a plan to start a retail brokerage, according to two people familiar with the matter who declined to be identified because they weren’t authorized to speak about it. Chris Keogh, who oversees derivatives and structured products at the firm’s wealth management unit in New York, had also been pushing to set up a trust venture that would allow the firm to sell investment products to clients. His plan was voted down internally because of concerns that Goldman Sachs wouldn’t be able to control the business, one of the people said.
Through Gao Hua Securities, Goldman Sachs won approval from Chinese regulators in late 2010 to offer investment products, including to institutional and affluent clients. Goldman Sachs estimates that of all ultra-high-net-worth accounts opened at the firm globally this year, more than a quarter are in China.
“The strategy in China is not just about IPOs,” said Cai. “That’s an important part of it, but so are all the other businesses we are building.”
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