Failed IPO shows China markets maturing

The first cancelled initial public offering in the short history of China’s stock markets is being seen as a sign of maturation. But mainland markets remain closer to adolescence than adulthood and their growing pains may yet become sharper, brokers and analysts warn.

This week, Nanning Baling, a small producer of automotive radiators and heaters, scrapped plans to raise about Rmb300m ($46m) on the Shenzhen Stock Exchange, after failing to attract bids from the required 20 institutions during bookbuilding. 

Not long ago, Chinese IPOs were a sure-fire path to riches for anyone lucky enough to get onboard before a listing, with share prices often doubling on their debut.

In markets rife with insider trading, the stunning first trading days were galling examples of how people with connections seemed to make all the money. For companies, the sight of so much cash left on the table was painful.

So, in 2009, the government began to change the rules. In the primary market, the China Securities Regulatory Commission limited the portion of shares that big companies could acquire and required issuers to be more transparent about pre-IPO valuations.

More significantly, it also took a big step back from the process, letting investors play a bigger role in setting valuations. Previously, the CSRC had in some cases mandated that shares be priced at relatively cheap valuations of about 20 times historical earnings to ensure IPOs went off without a hitch.

This new more relaxed approach did not achieve its desired effect immediately. Shares rose an average of 64 per cent one month after listing in 2009, even faster than the pre-reform performance of 2008, according to Dealogic.

But post-IPO gains have lost considerable altitude since then. They have averaged just 5 per cent one month after listing this year as the realisation has sunk in that the CSRC is not returning to its traditional ways, and has been approving IPO applications even in a down market.

This week’s cancelled listing might in the past have sounded the alarm in Beijing about weak investor sentiment. But Shang Fulin, the chief securities regulator, instead celebrated the failure, the first in the 20-year life of modern Chinese stock markets. “This is a great achievement,” he said.

Li Kefei, head of China equity capital markets at UBS Securities, says the failed listing was symbolic of deeper changes afoot in mainland markets.

“When I was doing IPOs two years ago, investors were not asking as many questions,” he says. “Now you can see a significant change. They do a lot of work and ask smart and tough questions.”

Companies going public have been the biggest beneficiaries of the changes. The ratio of prices to historical earnings was 19 for IPOs in 2008. Over the past year, the P/E ratio has averaged about 50.

Howhow Zhang, an analyst with Z-Ben Advisors, a Shanghai-based consulting firm, says it is not just down to regulators but also to investors and the domestic media that the IPO market was coming closer to international standards.

“But I don’t think anyone would call the Chinese market mature. Everyone who is involved in this effort knows it’s going to be even more challenging,” he says.

Now that fairly effective regulations are in place, it is time to improve the corporate governance of listed companies, Mr Zhang says.

Allen Gui, an analyst with Morgan Stanley in Shanghai, warns the heady days of huge gains for Chinese IPOs could easily return if market sentiment improves. Domestic markets are still dominated by retail investors, who account for about 70 per cent of daily turnover.

The Chinese IPO market is also lacking one crucial check on excess: the ability to short shares. Since last year, China has allowed investors to short index futures, but they are still not allowed to bet against most individual companies.

On the most heralded Chinese IPO of the year, shorting has been the best way to make money. Thankfully for investors who doubted its valuation, Renren, China’s largest social networking site, listed on Nasdaq.

Source: Financial Times

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