How are new stocks allocated? What are the routines?

The first-day increase in the trading of new stocks in the Hong Kong stock market may be more or less influenced by the distribution method of new stocks; in a few cases, the first-day trading range of new stocks may even depend entirely on their distribution method. Therefore, it is very necessary to understand the distribution rules of new stocks in the Hong Kong stock market before participating in new stock offerings, as well as the impact of different distributions on the potential performance of the listing.

1. Public Offering and International Placement

When we talk about the distribution of new stocks, we mainly refer to the allocation ratio between public offering and international placement of new stocks issued by listed companies. Public offering is for individual retail investors like us, while international placement is for institutional orders.

In general, new stock issuance will initially allocate 90% of the new shares to international placement, with the remaining 10% reserved for retail investors. For example, if the issuance scale is 1 billion shares, 900 million will be for institutions in the international placement, and 0.1 billion for retail investors.

Among the portion subscribed by retail investors, it is usually divided into groups A and B. Subscriptions below 5 million belong to Group A, while subscriptions above 5 million belong to Group B. When we often hear about 'top hammer', it refers to the highest level of Group B (usually half of the maximum subscription allowed in public offerings).

Generally, Groups A and B each account for 50% of the share allocation to retail investors. If there is an undersubscription in Group B and an oversubscription in Group A, the undersubscribed shares in Group B will be reallocated to Group A, and vice versa.

What if the total subscription from Groups A and B is still undersubscribed? Then, the undersubscribed portion will all be reallocated to the international placement portion.

What if both public offering and international placement together are still undersubscribed? Then, the company's listing will fail this time, and all subscription amounts will be fully refunded.

2. Callback mechanism for distribution.

The above is just a preliminary distribution between initial public offering and international placement of new shares. However, when the public offering reaches a certain level of popularity, the international placement cannot exclusively occupy 90% of the shares, but must allocate a portion back to the public offering, which also reflects the fairness principle in Hong Kong's new share issuance.

What are the callback rules? Taking the issuance scale of 1 billion as an example, for the vast majority of new shares, the standard callback rules are as follows:

When the subscription multiple of the public offering is between 15-50 times (including 15 times), that is, the public subscription amount is between 1.5-5 billion, the share allocated for public offering will increase to 30%, which is an amount of 0.3 billion. The international placement portion, due to callback to the public offering, will decrease to 70%, with an amount of 0.7 billion.

When the public subscription multiple is between 50-100 times (including 50 times), the public offering shares account for 40%, and the international placement accounts for 60%.

When the public subscription multiple reaches 100 times and above, the public offering and international placement portions each account for 50%.

So, what impact does different distribution ratios have on the performance of new shares after listing?

We can look for some patterns from historical data. Below is the statistical information on the relationship between subscription multiples and average increase since the listing of nearly 1000 new shares since 2016.

We can see that when the subscription multiple for public offering is less than 2 times, the average performance on the first day is the worst, with an average decline of 1.1%. The possible reason behind this may be that the new stocks are not attracting attention, and there is a lack of bids after listing.

On the other hand, when the public subscription multiple for new stocks is particularly hot, exceeding 500 times, their performance after listing is the best, with an average increase of 47%. This is mainly due to the high attention and strong liquidity of new stocks, attracting more bids after listing.

When the subscription multiple for public offering is between 2-15 times, the overall subscription is not too cold, but has not triggered a callback, with relatively low selling pressure. The new stocks in this range have an average increase of around 18.2% on the first day of listing, which is quite remarkable.

When the subscription multiple for public offering is in the range of 15-50 times, the overall trend is that the higher the multiple, the better the average increase, but still not as good as the increase in the 2-15 times subscription multiple range.

In addition to the regular allocation, for a few new stocks with very large issuance scale, the proportion of public offering may be drastically reduced. For example, in the early 2021 listing of Kuaishou, with a total issuance scale exceeding 40 billion Hong Kong dollars, the initial allocation to the public offering portion was only 2.5%, with a maximum proportion of only about 6%. This allocation method, although reducing the proportion and winning rate of retail investors, can indeed reduce the selling pressure of the public offering portion, bullish for its first-day performance after listing.

- Tricks callback and active callback

In most cases, the distribution method of new stocks does affect the stock price increase, but it is not decisive. There are only two exceptions, which are tricks callback and active callback.

First, let's see what tricks callback means. It is a situation where under certain conditions, the allocation of new stocks can reduce the portion that should have been callback to individual investors, with less callback. In other words, the institutions behind the new stocks are not willing to allocate shares to individual investors, which is a significant bullish factor for the performance of new stocks after listing.

Specifically, this is how it works:

If the public offering is more than 15 times oversubscribed, under normal circumstances, the public allocation ratio will not be less than 30%. However, according to the listing rules, if two conditions are met:

1. The subscription for the international offering segment is insufficient. In other words, if the issuance size is 1 billion, the international orders are less than 0.9 billion.

2. Within the price range of the offering price, a lower limit is set.

In this case, if the proportion of shares allocated to retail investors by the company is reduced to 10%-20%, it is called a "callback routine," also known as a "routine callback."

From the data during the first half of 2019 to 2024, although the fundamentals of the new stocks involved in routine callbacks may be generally average, their market debut gains and success rates are very good. Out of a total of 23 new stocks involved in routine callbacks, 22 rose on their first day of trading, with an average increase of up to 54%.

However, despite the clear overall profitability of new stocks involved in routine callbacks, it is necessary to point out two risks here.

First, whether the new stocks are subject to routine callbacks, most subscribers cannot know the inside information before the results are disclosed, so there is an element of speculation.

Secondly, although the historical winning rate is very impressive, following a set pattern does not necessarily mean an increase. For example, Tianju Dihe, which was listed at the end of June 2024, despite the majority of time in the grey market and the first day of trading having an increase of over 30%, the late collapse led to a final decline, breaking the undefeated status of following a pattern, and inevitably affecting the trend expectations of subsequent new stock offerings following a pattern.

Now that we understand following a pattern, what is active recalling?

This is the opposite operation of following a pattern, forcibly recalling shares originally not allocated to retail investors under certain conditions, not only increasing selling pressure for retail investors but also greatly dampening market sentiment. This naturally poses a significant bearish impact on the performance of newly listed stocks, hence active recalling is also known as malicious recalling.

Here is how it is done:

If there is oversubscription in the public offering of new stocks, but the subscription multiple is less than 15 times, under normal circumstances there is no need for a recall, with a retail allocation ratio at 10%.

However, as long as the new stock sets a lower limit price, regardless of whether it is under-subscribed or oversubscribed, the proportion of shares allocated to retail investors can be increased to a maximum of 20% (or the extra upper limit specified in the prospectus), this is called active recalling.

Based on data from 2020 to present, there are about 6 new stocks subject to active recalling, with the vast majority experiencing significant falls, averaging a decline of over 25%, causing substantial losses to the investors who got allocations.

So how to avoid the risk of actively recalling new stocks? The key is to control the position size.

Because the premise of active callback is that the oversubscription ratio of new stock public offerings does not exceed 15 times, meaning there won't be a regular callback. As mentioned earlier, new stocks with an oversubscription ratio between 2-15 times tend to have a relatively good overall increase. Therefore, many investors choose to speculate on subscribing to new stocks within this range, especially those with smaller market caps.

This may be a good speculative strategy for initial public offerings, but in case of an active callback situation, IPO investors are likely to end up with losses. Therefore, IPO investors are best advised to control their positions and limit losses, while engaging in speculative subscriptions.

Lastly, let's review,

Hong Kong's new stock offerings are divided into public offerings and international placements.

In terms of the allocation of public offerings and international placements, there is a callback mechanism. Usually, the more popular the public offering, the higher the proportion of the public allocation.

The subscription enthusiasm and allocation ratio of public offerings will affect the new stock's first-day trading price increase.

Stocks with high expectations of rising prices on the first day of trading usually experience a significant drop on the first day if subject to an active callback.