Risks and Rewards on China's New Stock Board

Risks and Rewards on China's New Stock Board
Reuters/China DailyCompany delegates of GEM, also known as ChiNext, at the listing ceremony Friday. Values of the newly listed companies surged.

By DAVID BARBOZA
Published: November 2, 2009
SHANGHAI — The opening of a Nasdaq-style stock board in China is already being seen as a watershed moment for the country’s capital markets, providing new but volatile opportunities for mainland Chinese investors and an alternative source of financing for start-up companies.

On Monday, the second day of trading on the ChiNext board, 25 of the 28 listed shares fell, many by the daily limit of 10 percent, while the benchmark MSCI index of Asia-Pacific shares outside Japan fell about 1 percent

Over all, shares fell about 8.5 percent on ChiNext, but the drop came after a day of gains that were astronomical and amid expectations that shares on the new board would be subject to big ups and downs. On Friday, the first day of trading on ChiNext, a secondary board of the Shenzhen stock exchange, the shares of some companies soared as much as 210 percent.

The first batch of the 28 companies listed — including film producers, software makers and pharmaceutical companies — raised about $2 billion in their initial public offerings, far more than the companies had hoped.

By the end of trading Monday, the combined market value of the companies was almost $19 billion, creating fortunes for the founders and initial investors in those companies.

China is already the world’s biggest market for initial public offerings this year, and its resurgent economy is flush with capital and investors with a big appetite for risk.

But trading experts have long complained that the mainland’s stock market system is seriously flawed, partly because of a misallocation of capital.

State-run banks lend primarily to state-owned companies, which tend to be inefficient. Listings on the Shanghai stock exchange and the main board of the Shenzhen exchange are dominated by government enterprises. Because there are few opportunities for stock listings on the mainland, young private mainland companies generally list their shares in Hong Kong, which operates under rules separate from the mainland’s, or overseas on the Nasdaq or New York Stock Exchange.

The government hopes to change that with the creation of ChiNext. The government is seeking to create a more efficient capital market system, one that would steer investment capital to small and midsize private enterprises — companies that can help reshape the economy through technology and innovation, rather than low-price exports.

“This is potentially a major game changer in China’s high-tech industry,” said Yu Zhou, a professor at Vassar College in Poughkeepsie, New York. “For about 10 years, the biggest problem for China’s innovative companies was finance. You know, it is veA Chinese investor monitors screens showing share prices at a security firm in Wuhan, central China's Hubei province on November 2, 2009. More than two-thirds of the shares listed on China's newly launched Nasdaq-style board ended limit-down on profit-taking on November 2, in only the second session after a wild debut last week, as twenty of the 28 stocks listed on the Shenzhen-based ChiNext fell by the daily trading limit of 10 percent, and analysts said there was room for further correction. CHINA OUT AFP PHOTOry hard for them to get loans from state-owned banks.”

Although ChiNext is tiny when compared with the Shanghai and Hong Kong stock exchanges, regulators hope it will eventually compete with Nasdaq and entice more Chinese companies to list with it.

ChiNext is also expected to give a boost to venture capital and private equity markets in mainland China, which have been hampered by a system that until now has not provided investors with what industry insiders call an exit strategy — a way of eventually cashing out of their investments in small companies through a domestic stock market.

There are big challenges to creating a stock board similar to Nasdaq, which includes companies like Microsoft, Intel and Google. For instance, volatile stock prices and high valuations could hurt the new board’s credibility with entrepreneurs and investors.

Chinese investors are known to speculate, favoring momentum buying and selling rather than the underlying fundamentals of a company, analysts say. Indeed, the casinolike nature of the Shanghai stock exchange and the main Shenzhen board, combined with government intervention, have added to the volatility of the mainland markets.

Analysts warn that ChiNext could also be prone to similar speculative frenzies.

Andy Xie, an economist who formerly worked at Morgan Stanley, is already calling ChiNext a “V.I.P. table on top of a big casino.”

Chang Chun, an expert on financial markets at the China Europe International Business School in Shanghai, said that China needed a market to serve start-ups, but “the issue is the maturity of Chinese investors.”

Before trading opened Friday, he said, regulators created rules to guard against excessive volatility and even warned investors that they would crack down on aggressive speculation. Still, the opening Friday — with 28 companies beginning to trade at once — was marked by wild price swings.

The buying was so feverish that regulators, trying to calm the market, temporarily suspended trading of the 28 companies at different points, and analysts warned of the risks posed by excessive speculation and inflated stock prices.

One cause of concern was the huge valuations of the first batch of stocks.

The average company on ChiNext has a price-earnings ratio of about 100 meaning investors are paying $100 for every $1 of 2008 earnings. By comparison, the Nasdaq 100 index has a price-earnings ratio of 23.6, according to Bloomberg.

ChiNext stocks are also priced far above Shanghai-listed stocks, which have long been considered inflated by the standards of more mature markets.

Hundreds of Chinese companies are eagerly awaiting their turn to list on the ChiNext, and many analysts say the exchange will fill an important need: directing financing toward smaller start-ups that help rebalance economic growth. Ms. Zhou at Vassar said she had heard that there were more than 1,000 companies in Beijing’s high-technology district alone that met the requirements for listing shares on the ChiNext board.

http://www.nytimes.com/2009/11/03/business/global/03yuan.html?pagewanted=2&ref=business