China’s attempt to restore confidence in its domestic stock market is paying off, with a couple of successful deals already on the board. Will it be enough to reinvigorate the struggling A-share IPO market?
The IPO market in China has been undergoing an extensive overhaul since the beginning of the year in a move to promote market-based pricing. The effort to restore confidence in China’s domestic stock market is paying off and a couple of positive signs are already on the board.
In the China market, the “three highs” phenomenon – high PE ratios, high IPO prices and high fundraising sizes – has previously drawn heavy criticism.
Continuous losses from buying into IPOs have driven many institutional and retail investors away from that market, prompting the China Securities Regulatory Commission, the country’s securities market regulator, to take action to correct the situation.
As a result, 89 companies raised Rmb64.56bn in the first five months of this year, down 55.90% year on year. In the first five months of 2011, 137 companies raised Rmb146.39bn.
The CSRC has introduced a series of IPO reforms since late April. To rekindle investor interest in IPOs, the regulator scrapped the three-month lock-up period for institutional investors and raised from 20% to 50% the proportion of shares institutions can buy in an IPO.
In order to ensure fair pricing of IPOs, the CSRC has required issuers to hold related consultations again if it intends to sell its shares at a valuation 25% higher than listed peers. An issuer is also be required to go through a listing hearing again, if its fundraising size is much higher than the original target because of a high IPO price.
The CSRC moves are working. For instance, Fortune SGAM Fund Management, a joint venture between Societe Generale and Chinese steel giant Baosteel Group, is again participating in A-share IPOs, after announcing a cessation of such activity at the beginning of the year.
Statistics from the Shenzhen Stock Exchange also show a rise in institutional participation in IPOs, while valuations of new offerings have declined.
According to the statistics for the period from late April to June 8, there were 18 IPOs completed on the Shenzhen Stock Exchange, a market that has been far more active than the Shanghai Stock Exchange year to date.
Each of the listings received an average of 118 bids for the institutional tranches, up 69% before the IPO reforms. The average valuation of the 18 new listings was 30.61 times, about 23% lower than for the pre-reform IPOs.
“One of the key targets of this round of IPO reforms is to tackle the ‘three highs’ problem. From this perspective, the measures have been effective. A more rational valuation of new listings has lifted market confidence and eased risks in the secondary markets,” said Xiang Weida, director of research at Great Wall Securities.
Although there is renewed investor interest in IPOs, not many believe they can rely on the CSRC to reinvigorate the struggling A-share IPO market.
“The tepid sentiment in the IPO market is mainly due to the slower-than-expected growth of the Chinese economy, which has severely damaged investor confidence. The revival of the IPO market depends less on the reforms the CSRC has initiated, but more on the recovery of the macro economy,” said Shen Wei, managing director of investment banking department at Orient Securities.
While trying to move the IPO market to a more market-oriented direction, the CSRC has not given up exercising its administrative intervention to ensure no jumbo floats reach the market in the short term, so as to protect the fresh sign of recovery.
“One of the key targets of this round of IPO reforms is to tackle the ‘three highs’ problem. From this perspective, the measures have been effective. A more rational valuation of new listings has lifted market confidence and eased risks in the secondary markets”
The regulator has sent a clear message to issuers that any IPO of over Rmb5bn will not be granted listing approval. If they want to list, they will have to trim their fundraising sizes.
This requirement, coupled with the 25% cap on valuation, has been criticised as regressive to the market-based mechanism.
Too much intervention
“Those administrative interventions are truly regressive. After all the reforms, the regulator finally managed to push the IPO process to close to a marketed-oriented practice, but now it is almost like going back to the start,” said a banker.
Although China’s efforts to reform and streamline its listing process are gathering pace and bringing quick results, some bankers still see the rule changes as having brought no fundamental change to the IPO market.
“The ‘three highs’ problem cannot be fixed only with the implementation of some rules to regulate the behaviour of intermediaries because they can always find loopholes,” said Orient Securities’ Shen. “When the IPO market turns hot, the ‘three highs’ problem will likely reappear.”
“The most effective way to solve the high IPO prices in China is to put issuers and underwriters in opposite camps,” said Shen.
IPO issuers and underwriters normally have common interests. For banks, the more funds they raise, the higher their underwriting fees. As such, some bankers urge the regulator to make hard underwriting mandatory and let the banks bear the consequences of pricing an IPO too high with their own money.
To see the digital version on this report, please click here.
