End of the Initial Public Offer (IPO) ban in China – What impact will it have on the equity markets?

Bloomberg News Online reported on January 17, 2014 that the so-called IPO ‘freeze’ will end this morning (Hong Kong/Singapore time) when the first Chinese IPO, Neway Valve (Suzhou) Co. (603699) is about to make its debut on the Shanghai bourse. The Company is a manufacturer of industrial valves, and it has raised 1.5 billion yuan (USD 241.0 million) after selling 82.5 million shares at 17.66 yuan. The deal values Neway Valve at 46.5 times its FY 2012 earnings, compared with 33.9 times for its listed industry peers. This is based on a Company statement released on January 08, 2014.

With the debut of the first major Chinese listing, the question is how will it impact China’s equity markets, namely the Shanghai Composite Index? According to data taken from Thomson Reuters, if one were to take a look at the index performance, it is currently trading year-to-date on the downside of approximately 4.4 percent, and on a one-year comparison, it is trading downwards by approximately 12.4 percent. The Price-to-Earnings (P/E) multiple is trading approximately 7.6 times forward earnings, with total market capitalisation of USD 14.5 trillion. As of the last close of trading on January 16, 2014, the index stood at 2,023.70 up by 2.0 basis points on an intraday basis. A chart showing the stock market trend on a daily basis is as follows:

Chart showing the daily Shanghai Composite Index over a year - January 17 2014

Source: StockCharts.com

Based on the Candle Stick chart on a daily basis and extrapolated over the course of one year, it appeared that the index is trading downwards with no apparent upside, as shown by the 50-day and 200-day moving average (MA) overlays. The index has not been able to keep up with its global peers, including the US S&P 500 stock index, which was up by approximately 30.0 percent in 2013. The start of 2014 has also not provided any catalyst for the Shanghai Composite Index to trade higher, or stage a rebound from its current lows, and it is still quite early to tell whether the end of the IPO ban will bring about much volume, and liquidity into the Chinese equity markets.

According to the Jan 17 Bloomberg News article, it reported that based on a November 2013 statement provided by China Securities Regulatory Commission (CSRC), it plans to have about fifty companies approved for listing by the end of January 2014. There are also additional plans to list approximately sixty to eighty companies each month, involving 700 companies in the pipeline which are still undergoing reviews by the CSRC before the respective approval stamps are issued. The CSRC has also conducted pricing spot checks on companies, and underwriters involved in the process. This to ensure that companies that are preparing to list will have strong corporate governance systems build in place, including statements that are being accompanied in the respective IPO prospectuses. If there were to be misstatements found in the IPO prospectuses, the CSRC will not hesitate to permanently suspend these companies from listing. These and various other measures being introduced in early 2014 are some of the efforts made by the Chinese government to increase market confidence, and boost liquidity in the financial system. The CSRC has plans to adopt the US-style IPO registration system where companies will have to subject themselves to regular reviews before being approved for final listing.

The latest announcement by the CSRC comes two days after a potential company; Jiangsu Aosaikang Pharmaceutical (300361) Co. announced its delay of an IPO slated for Shanghai’s ChiNext board for startups, which it said was priced at 21.0 percent premium to its industry peers. Nanjing-based Aosaikang makes cancer drugs, said in a statement that it delayed its 4.05 billion yuan offering due to the relative large size of the offering without providing additional reasons beyond it. Other Chinese companies which are currently planning to market their IPOs have now settled for lower valuations, including Beijing Utor International Travel Service Co. (002707), Hebei Huijin Electromechanical Co. (300368), and Yangzhou Yanjie Electronics Technology Co. (300373), all of which have priced their IPO shares at below valuations for their respective industries after being rejected by most investors citing that bids for the stocks were too high. This was disclosed in a recent statement from the Shanghai Stock Exchange which is overseeing the IPO process, in conjunction with the CSRC.

At first glance of the various statements issued by these potential IPO debutants indicated that relative valuations, and IPO price ranges appear to be set at a very high level, and I believe that most of these Chinese companies are trying to get the last buck out their potential stock price upon approval for listing. It shows that many of these Chinese companies have relatively high expectations, but these expectations do not seem to conform to the market norms, which could signal potential further weakness in the Chinese equity markets going forward due to the relative high valuations to begin with.

The short-term impact from the various plans announced by the CSRC could be a correction in most of the small-cap companies’ valuations due to the volume and liquidity being generated. This is according to an analysis done by investment bank, UBS Inc., however over the long-run, it is expected that more Chinese investors, including those coming from the retail end to slowly come out and make their bets of these companies, thus generating additional interest from the rest of the Chinese population. But, at this point in time, it is still early to forecast any expected reactions by the Chinese equity market investors as market confidence is still quite low relative to the previous years as a result of the various crackdowns on dubious Chinese companies which have cheated many of these investors’ moneys.

Some of the issues which might have led to the lack of market confidence include not having a transparent and open IPO registration system, lack of investor education, and the common Chinese people mentality of viewing the equity markets as gambling casinos, which could offer potential short-term gains, at the expense of one’s retirement nest. It is hoped that with stringent, and thorough checks conducted by the CSRC to ensure good quality companies are being approved for listing, more Chinese investors will participate in the trading of these companies. However, I believe that in order to ensure sustainability and increased market confidence, there ought to be a shift in the mentalities of these Chinese retail investors that investing is not the same thing as gambling, and it has to be on the responsibility of each individual investor to be educated and learn the basics of investing before jumping into the whole IPO frenzy, as seen in the past.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc