Huatai Securities Equity Raise - If you are bullish volumes, it's cheaper than it looks

Ke Yan just wrote a piece in the Smartkarma series on IPOs & Placements about Huatai Securities' upcoming H-share IPO saying "Take the Deal!"

I agree. As long as you think the business continues on as-is, the shares are CHEAP.

There is a fair bit of dilution in this deal - There are 5.4bn shares outstanding and Huatai is offering 1.4bn new H-shares with a greenshoe of another 210mm shares. Assuming they will issue those, that will be 7.01bn shares outstanding after the deal. The number of shares will go up 30%!

An obvious question is how much will Huatai be able to increase earnings based on this increase in equity? Will their run-rate suddenly jump 30%?

Unlikely. But it almost doesn't matter. This is counterintuitive but the math works out that way, as long as you think the business continues to do as well as it is currently doing.

In this piece I suggest a quick-and-dirty model to measure Huatai's potential monetisation for increased demand for margin trading balances. A spreadsheet is attached to allow you to change inputs.

Even using very basic assumptions, one can see the equity raise will dilute current ROE and raise PER for the current year, but has the potential to boost net revenues quite substantially NEXT fiscal year as long as Huatai earns an acceptable ROE on the incremental equity, and its existing equity returns the consensus 15%.

Why? Because the Hs will price at a big discount to As, and because the increase in equity is substantial - 64% at the low end and 75% at the upper end of the pricing range. And earning an incremental 10% ROE per year on that huge increase on equity means a substantial rise in profits. This is the math of discount issuance on high-PBR stocks if capital can be deployed.

CONCLUSIONS:

• As long as you are not outright bearish China brokers and the China A-share market, and you don't believe all mainland brokers will fall all over themselves to raise more equity (because other brokers will have similar economics on capital raises), then this is a deal to be bought.
• If a host of other mainland brokers announce capital raises in the short-term, the PER discount advantage that Huatai would have would substantially diminish.
• First-mover has the good optics - low forward PERs make this look good.