Method of finance used by Chow Tai Fook and roles played by HSBC - Assignment Example

?323 KM FINANCIAL SERVICES ASSIGNMENT Table of Contents Method of Finance used by Chow Tai Fook Jewellery Group Limited 3 Introduction 3 Method of Financing and its merits and demerits 3 Roles played by HSBC 5 Role of HSBC as a global coordinator 6 Role of HSBC as Book runner 7 Role of HSBC as a sponsor 9 References 11 Method of Finance used by Chow Tai Fook Jewellery Group Limited Introduction Chow Tai Fook is a leading brand worldwide engaged in different types of business which include property development, transportation, hotel, casino, jewelry, etc. It is an enterprise based in Hong Kong based. The brand name ‘Chow Tai Fook’ is most common Chinese speaking people. Since its foundation, Chow Tai Fook or CTF is a leader in its market segment and enjoys the top position in market share of PRC, as well as Hong Kong and Macau. CTF possess a very wide range of jewellery products with its main focus on producing high-end luxury jewellery items along with gem-set jewellery, platinum jewellery, watches, etc. The retail network of CTF is quite extensive with its points of sale (POS) of jewellery and watches spread all across PRC, Hong Kong and Macau, thus maximizing its exposure and taking sales to new heights every year. Authenticity and trustworthiness are the two main key aspects on which the brand of CTF is recognized. CTF uses a vertically integrated model which is quite effective in having a good control over the entire business process. Method of Financing and its merits and demerits The products of CTF are divided into four main categories for the purpose of financial reporting. They are: a) gem-set jewellery, b) platinum/karat gold products, c) gold products and d) watches. The method of financing of CTF primarily includes borrowings from bank, gold loans and advances from related parties or companies. Bank borrowings include both secured and unsecured loan. Bank borrowings were not much up to 2010, with no secured bank borrowings at all. From 2011 onwards bank borrowings of CTF increased significantly. The various figures of bank borrowings for past three financial years are as mentioned below: Secured loan amounted to HK$ 700 million in FY2011 and nil in the FY2009 and FY2010. Unsecured loans amounted to HK$ 113.6 million, HK$ 160.3 million and HK$ 2181 million for the financial years 2009, 2010 and 2011 respectively. Gold loans amounted to HK$ 2060.8 million, HK$ 2189.2 million and HK$ 3931.6 million for the financial years 2009, 2010 2011 respectively. Loans or advances from related parties which are due amounted to HK$ 4726.8 million, HK$ 4639.8 million and HK$ 7833.3 million for financial years 2009, 2010 and 2011 respectively. The unsecured bank borrowings of CTF primarily serve the purpose of financing working capital, purchase of materials, etc. CTFE guarantees some of these Honk Kong unsecured bank borrowings. Secured bank borrowings of CTF are totally guaranteed by CTFE and certain assets owned by related companies are held as security of these loans. The bank borrowings carry a variable interest rates ranging from 0.30 % to 1.25% per annum over HIBOR or 90-110 % of the PBOC lending rate benchmark per annum. The figures show that there was a significant increase in bank borrowings in the FY2011, primarily due to increase in inventory because of the expansion efforts of the company. Gold loans include both secured and unsecured short term gold related facilities provided by major financial institutions of the world. The interest rates of gold loans are quite low ranging from 1.25% to 3.5% per annum. There was a significant increase in gold loans in the FY2011 attributed to the fact of increase in gold inventories and business expansion. Regarding advances from related parties, they are unsecured; carrying no interest charges and is repayable on demand. The related parties include the CTFE group and close family members of a director of the Company and an entity having common director of the Company. Until recently, CTF have made a global offering of 1,050,000,000 shares to raise its share capital. Out of these offerings, 52,500,000 shares will be offered to the Hong Kong Public and the rest as international offering. That means 95% of the offering is for people globally. Out of the shares allotted for Hong Kong Public offering, 3,675,000 shares are employee preferential offer. With a minimum offer price of HK$ 15 per share, this IPO is set to raise HK$ 15.8 billion for CTF. Thus, it can be concluded that CTF relies mostly on gold loans for financing their business operations. It has got its merits and demerits. Compared to bank borrowings gold loans carry significantly lower interest rates and CTF being in the business of jewellery involving gold, impact of fluctuations or changes in gold prices on the gold inventories of CTF will be reduced significantly. This helps in reduction of finance cost of CTF, thereby increasing the profit figures. CTF uses external financing through gold loans and bank borrowings to support their business growth and expansion. These are all short-term borrowings and are a part of the current liabilities of the Company. These borrowings are mainly utilized to finance the inventories, which have increasing trend in the past few years to help for the cause of business expansion of CTF in the form of increase in POS and product varieties. CTF, with its brand value and reputation in the market have always maintained a good relation with its bankers and have no difficulty in repaying their borrowings. But reliance on its existing bankers to obtain financing from them does have some risk factors involved. These risk factors can be summed up as the uncertainty in future financial condition of CTF, uncertainty in their operating results and cash flows and also uncertainties in global and domestic financial market scenario which may result in changes in monetary policies, lending policies and lending rates in the financial market. So refinancing of these short-term borrowings can be a concern then. But all in all it is a good financing policy adopted by CTF to rely mostly on short-term borrowings that get matured every year and are renewed every year thus helps to keep the finance cost low. Regarding the IPO by CTF, as mentioned earlier, CTF is about to raise its share capital amounting to a minimum of HK$ 15.8 billion, which is around 10.5% of issued share capital of The Company. This will boost up the expansion proposals of the Company and ultimately lead to robust growth of CTF. Moreover, the net proceeds of the offering will be utilized by CTF to repay back its entire related party advances and loans. Equity capital being a cheap capital, CTF decided to go public to gain access to this method of financing (Draho, p.339). Roles played by HSBC Hong Kong Shanghai Banking Corporation Limited or HSBC is one of the largest banks in the world and provide financial services globally across the world. HSBC is primarily involved in four global businesses. They are: a. Retail Banking and Wealth Management b. Commercial Banking c. Investment Banking and d. Global Private Banking. The HSBC has a major presence in most of the world’s financial markets. HSBC plays a vital role in CTF and with regards to the global offering by CTF, HSBC acts as: a) Joint Global Coordinator b) Joint Book runner and c) Sponsor. The various roles and functions played by HSBC in the global offering of CTF are mentioned in the subsequent paragraphs. HSBC acts as a joint global coordinator, joint book runner and joint sponsor in the global offering offered by Chow Tai Fook Jewellery Group Limited. Role of HSBC as a global coordinator The Hong Kong Shanghai Banking Corporation Limited along with Goldman Sachs (Asia) and others like J.P. Morgan Securities (Asia Pacific) Limited as well as Deutsche Bank AG (Hong Kong Branch), was one of the joint global coordinators involved in the global offering offered by CTF. As a global coordinator HSBC had to play the most vital role in the global offering of shares of CTF. The whole IPO process was led and governed by HSBC. HSBC had the responsibility to coordinate the whole process of IPO from beginning to the end and even beyond that. The global offering structure was formulated by HSBC. As a global coordinator HSBC was the overall manager of the syndicate of banks (Iannotta, p.61). HSBC was involved in deciding the pricing issue as well as underwriting and distribution of the global offering. It being a global offering, the shares can be offered to people globally all over the world. As we see here that, 95% of the offering is international offering. So HSBC being one of the joint global coordinator had to play a leading role in selling the shares worldwide and is a part of every tranche in of the global offering. HSBC was also involved in documenting the whole offering transactions. As the name suggests, global coordinator has a coordinating role, whereby it has the task of coordinating amongst all the related parties in the transaction of global offering. With the presence of HSBC both locally in Hong Kong and globally, it was an automatic choice of CTF for appointing it as one of the joint global coordinator for both the Hong Kong public offering and international offering. Being the global coordinator, HSBC had the task or role of selling the shares all over Hong Kong and globally, wherever it is licensed to do so. On behalf of the underwriters, HSBC, as a global coordinator has the responsibility to properly identify the investors who have applied for both Hong Kong public offer and international offer and have been allotted shares in international offering. The investors may be required to furnish relevant information ordered by the global coordinator to ensure that the ones who have been offered shares in international offering are not offered with shares in Hong Kong public offering. The global offering offered by CTF has an offer size adjustment offer which can be exercised by the global coordinator at their discretion after consulting with the company and the selling shareholder. This option is available when there is a greater demand for shares in the market and would not be used for the purpose of stabilizing price. The offer size adjustment offer provides the option of increasing the number of shares available in the global offering if there is a greater demand of shares and it can be determined latest by the date when the offer price of the share is determined. Global offer of CTF has also an over-allotment option. This option is also at the discretion of HSBC, who is a joint global coordinator for the public offering concerned. This option is exercisable during the 30 days period from the last date of application for Hong Kong public offering. While this option is exercised the selling shareholder will have the option to sell up to 15% of the shares that have been offered to them initially. Thus, HSBC played the most crucial role in global offering by CTF. Role of HSBC as Book runner As mentioned earlier, the offering was both a Hong Kong Public Offering and an International Offering and HSBC having its presence both in Hong Kong and other places worldwide, was the joint book runner of the offering. In a public offering, book runner plays the most important and critical part. HSBC played a secondary but a key role in CTF IPO as a book runner and had the responsibility to control the list of all subscribers of the IPO (Ramirez, p.74). HSBC had to keep a list of all the orders placed by the investors and then had to decide upon whom to allocate the shares amongst those investors who have applied for it. The book-building task is also a responsibility of HSBC. The investors who are willing to apply for shares in international public offering are required to specify the number of shares they are willing to pay for and are also required to disclose whether they agree to any offer price or a particular offer price of the global offering. This is the process of book building and is to be controlled by HSBC and other joint book runners. This process of building is carried on till the last date of Hong Kong public offering. The offer price can be set below the minimum offer price mentioned in the prospectus by the book runner after consultation with the company and amongst the joint book runners, along with HDBC. The pricing of the shares and other characteristics of an IPO is to be decided by a book runner. An investment bank’s reputation depends on the correct pricing of an IPO. HSBC as a book runner had the same responsibility of pricing the IPO and it was priced in the range of HK$ 15.00 to HK$ 21.00. HSBC has top ranked analysts who provide the service of providing analysis reports about the aftermarket response. As a book runner, with the help of their analysts, HSBC had the responsibility of explaining about the business carried out by CTF in a very lucid and simple way. The number of book runners act as that many number of market makers, who are to trade the shares in the market. HSBC, being the book runner was the dominant market maker for the CTF shares. The responsibility to determine the size of the issue in an IPO is in the hands of the book runner. HSBC had that discretion in IPO of CTF. Overallotment option can be exercised by HSBC, in case of price drop of shares in open market. As a book runner, HSBC has the option to either buy or sell the over-allotted shares of CTF to prevent under pricing and overpricing of shares, respectively. This can be explained further in the following way: In order to stabilize the offer price of an IPO, an investment bank as a book runner can make use of the “Green Shoe” option or the overallotment option. Overallotment means selling of more number of shares than that are being offered during the IPO. The investment bank like HSBC does so by creating a short position for itself, that is, the shares are sold without owning them and it is done by over allotting shares to the potential investors. The investment bank who acts as a book runner is given the authority to buy shares from the issuer like CTF in this case or even from the shareholders who are willing to sell the shares. After purchasing the shares from the issuer or from the shareholders, the investment bank has to return back the shares that have been borrowed, but those shares are already present as call option to the bank. Two possible outcomes can result out of these. They are: a. If the price of the share drops, then the investment bank tries to buy shares from the market so that it can prevent the fall in price of the shares, and then when it gets stabilized, the investment bank delivers back the shares that have been borrowed. Thus in this case Green Shoe option is not exercised. b. If the price of the shares rises, the Green Shoe option will be exercised and the investment banks without any costs are able to cover its short (Espinasse. p.148-166). This is about the function of a book runner in case of allotment of shares subscribed in an IPO. As a book runner HSBC also has the responsibility of drafting the prospectus of the IPO. The structuring of the IPO process is done by the book runner. Role of HSBC as a sponsor Here, HSBC is one of the joint sponsor along with Goldman Sachs (Asia) L.L.C. and J. P. Morgan Securities (Asia Pacific) Limited. As a sponsor, HSBC has the responsibility of providing advice regarding corporate finance to CTF in relation to the listing of shares offered in the IPO. The sponsor also has to provide professional advice to CTF regarding all the documentation required for listing of the shares. As a sponsor HSBC also has to assist CTF with appointment of other professional advisers and coordinating the responsibilities of those advisers. Liaising with the respective stock exchange is also one of the responsibilities of a sponsor in IPO. Independence from the issuer is also a vital characteristic of a sponsor. In most of the cases a leading bank, who acts as the global coordinator of an IPO by a Company acts as a sponsor of the Company. HSBC acts both as a global coordinator and as a sponsor for global offering offered by CTF. Thus, HSBC being the sponsor had the responsibility of liaising with the controlling authority or the exchange. HSBC appointed as the sponsor of the global offering was involved in negotiation with the exchange about the contents that are presented in the prospectus of the IPO. Thus sponsors are the financial advisors to the company who is going for public offering. Role of HSBC as a sponsor in global offering by CTF includes providing ideas to CTF regarding the raising of equity capital through public offering by utilizing their insight of market as well as intelligence of corporate finance. HSBC already has strong track record of being the sponsor in many global offerings of different and this offering by CTF is no exception. The presence of HSBC in most of the emerging of the world is what makes them the choice of being sponsor of many public offerings by different companies. Thus, it can be concluded that HSBC played one of the pivotal role as an investment banker of CTF. HSBC was at the centre of all the proceedings of the global offering and had a great responsibility in raising share capital for CTF successfully. References Draho, J. The IPO decision: why and how companies go public. UK: Edward Elgar Publishing, 2004. Espinasse, P. IPO: A Global Guide. Hong Kong: Hong Kong University Press, 2011. Iannotta, G. Investment Banking: A Guide to Underwriting and Advisory Services. Germany: Springer, 2010. Ramirez, J. Handbook of Corporate Equity Derivatives and Equity Capital Markets. UK: John Wiley and Sons, 2011. Read More