Newsletter February 2006

Foreign listed Chinese companies to apply for mainland listing   Chinavestor noticed when China Mobile (Hong Kong) Ltd. (CHL), the world’s biggest wireless carrier, announced on Dec 13, 2005 that it is seeking to sell shares domestically to complement Hong Kong and New York listings. And again when Aluminum Corp. of China (ACH), the world’s second largest alumina producer, announced plans to take its A-share companies private, paving a way for its own listing in mainland China. The Company will need a total of more than 5.6 billion yuan ($694 million) to buy the shares it does not own in it’s A-share units. And again after Guangshen Railway Co., Ltd. (GSH) announced that the shareholders conference held on January 20 had approved its plan of issuing shares on the Chinese A-stock market within a year. One would argue; why do prominent Chinese companies reverse the trend and pursue domestic listings on a market that is poorly regulated and is lacking capital? For example, Chinese mainland companies sold US$18.9 billion worth of shares in Hong Kong last year, more than four times the amount raised at home after mainland regulators halted public share sales in May to allow for conversions of non-tradable stock. Besides low liquidity, China’s main index, the SSE Composite, was Asia’s worst performing major benchmark stock index in both 2005 and 2004. It is less known but just as important that in 2005 the volume of trading on the Shanghai stock exchange fell to 5 trillion yuan ($620 billion), a fall of 35.0 percent on 2004; and trading on the Shenzen stock exchange fell 22.5 percent  to 1.2 trillion yuan ($149 billion). For one, for example China Mobile could raise theoretically more cash by pricing a stock up to 40 times its historical earnings—more than double the Hong Kong stock market’s average valuation. Up until 2005, China’s stock were valued as high as 40 times earnings compared with Hong Kong’s 15 times, but their sharp fall has wiped out the gap and they now hover at Hong Kong’s levels. For two, regulators are keen to introduce large, quality companies onto immature domestic exchanges. Allowing overseas-listed companies to sell shares in the mainland may help boost the total value of mainland’s stock market to third in Asia by the end of next year from seventh. PetroChina, Construction Bank, Bank of Communications and Shenhua Energy Co., the mainland’s biggest coal producer, are possible candidates. As the Vice Chairman of the Standing Committee of the National People’s Congress, Cheng Siwei said, “Raising the quality of China’s listed companies is the only permanent cure  that can ensure public investors’ fundamental interest. If listed companies have no investment value, then no foreign institutional investor would be foolish enough to invest and trade in shares of listed Chinese companies. The overall quality of China’s listed companies is not high.” Chen’s remarks go a step further than just regulatory changes. He realizes that it is impossible to  rely on the stock ownership reforms alone to invigorate the market. The stock market needs capital inflows to be invigorated. So far China’s stock market regulators have pushed companies listed on the two local bourses to convert non-tradable stocks held by government agencies—which accounted for about two thirds of market capitalization— into tradable shares. With the share reform program well under way, talks have started to swirl that regulators may soon lift the freeze on IPOs. There are more opportunities for resuming IPOs this year because more than one-third of companies have already joined or completed the state share reform. Just to remember, last year Beijing unveiled its share reform program and banned domestic IPOs. China’s regulators stopped new issues to avoid a flood of equity as companies pursued plans to make more than US42000 billion of mostly state-owned stocks tradable. Some 339 listed firms joined the plan in its first seven months, accounting for a third of market capitalization. So it is evident that the Chinese government has been trying to amend rules and regulations that apply to the equity markets, listed companies and investors in China, in order to make the markets more efficient and transparent to increase investors’ confidence level. They want to eliminate the non-tradable portion of shares of listed companies and to attract new and financially strong companies into the markets. They want to regain investors’ confidence. Just to see how low that confidence level has dropped, consider the current situation. Because of the fundamental problems and inefficiency of the Chinese markets, the majority of investors have become day-traders. There are hardly any long-term stocks to pick, no matter how well the company is run.  According to people familiar with the situation in China, only charting and insider information can make money to investors. To regain confidence, Beijing has been expanding investment quotas for foreign firms. So far China’s regulators have granted 30-plus overseas firms, including Deutsche Bank AG and HSBC Holdings Plc, approval to trade so called A-shares in more than 1,300 firms, as well as treasuries and corporate bonds. And the appetite just keeps growing. UBS, for one, wants to increase its quota to as much as $1.3 billion after using up its initial $800 million quota in September 2004. UBS had applied to Beijing for an additional quota of between $300 million and $500 million last year. The push is driven by the overwhelming demand from clients. The Swiss bank said it was also awaiting approval to secure a stake in Beijing Securities Co., which may be received within the next few weeks. In September, UBS said it planned to invest 1.7 billion yuan ($210.7 million) in Beijing securities as part of its restructuring work and industry sources have said that will help UBS to own one-fifth of the domestic broker in return. And on January 4th, China announced that foreign institutional investors, such as banks and brokerages, will be allowed to trade the yuan-denominated A-shares of listed companies. Trading the A-shares was largely restricted to domestic Chinese investors until now. From January 31, foreign investors with assets of at least $100 million will be allowed to  invest in them, provided they keep the shares for at least three years. Besides foreign capital, Shanghai and Shenzen stock markets need companies with true investment value. Based on the latest estimate only 30 percent, or about 400 companies, have investment value and most of the remaining 900 or more have relatively low investment value. China’s bourses could make a lasting recovery only if more profitable companies are allowed to replace the sluggish state-owned ones that now dominate it. By attracting CHL, GSH and ACH, Beijing chose the right medicine.     China 2005 trade surplus soars above $100 bln   When China’s trade surplus had topped $101 billion last year, triple the figure of 2004, the world noticed. China had a record monthly trade surplus of about $13 billion in December, well above the $10.3 billion expected by most of the analysts. The Commerce Ministry issued data for 2005 high-tech trade, including its share of total imports and exports—enough information for the overall trade figures to be calculated fairly accurately. Now the question is this. Where does that $100 plus billion go ? And on the same note, what will slow the trade surplus growth? Well, the obvious answer is that the surplus goes to the treasury. Then the treasury buys foreign reserves, notably U.S. dollars. The China Business News reported in late December that China’s foreign exchange reserves rose by $9.3 billion in November to a record $794.2 billion. China’s foreign exchange reserves, the world’s second largest, are expected to surpass 1 trillion by the end of 2006. What effect might it have on the U.S.? First of all, China cannot sell current dollar assets. Actually China is in a very unhappy position of being at risk of a significant decline in the value of their reserves. Eventually the dollar will depreciate quite a bit, particularly against Asian currencies. So they  are at risk of their reserves depreciating against their domestic currency. They can’t really diversify out of dollar holdings because the minute they start to do that they impose losses on themselves. It is possible that China will diversify newly added foreign exchange reserves, but it’s going to be impossible for them to divest existing dollar-dominated assets. Regarding the second part of the question, i.e. what will slow the trade surplus growth, first we have to realize that the big driver isn’t on the export side but on the import side. Based on data available so far, export growth slowed a bit, but import growth was barely half that of 2004, so there has been this ballooning of the trade surplus. The big question is whether import growth starts to pick up again. The reality is that China has tremendous production capacity in most of the things people are buying—consumer electronics, automobiles, clothing. So GM may sell more autos in China, or more foreign companies may sell more computers, but those will be made in China. What might be a solution is the revaluation of the yuan. A revaluation would contribute to the reduction of U.S. current account deficit. If China were to revaluate its currency significantly, it still would have a trade surplus with the U.S., but to a lesser extent. A stronger yuan would make Chinese products in U.S. markets more expensive. In return, the U.S. would import less goods from China. A stronger yuan would also increase China’s buying power for aircraft, machinery and consumer durables.  A stronger yuan would increase domestic spending, since average Chinese will have more purchasing power for foreign made consumer goods. And finally, China is better off by relying on its own 1.3 billion consumer than on investment climate for foreign firms.   2005 Q4 February Earnings Releases     Earnings season kicked in in China on Wednesday, January 25th when AsiaInfo Holdings (ASIA) reported a shortfall in net revenue and a net loss. This had little impact on the market as the Hong Kong benchmark, the Heng Seng index, kept nearing its five year highs. Renewed confidence in stocks and an expected influx of new capital from institutional buyers will boost China’s markets in 2006, building on a rally that has seen shares rise 13 percent in the last two months. Retail investors are also expected to return to the market as worries fade over a plan begun last year to float $250 billion worth of non-traded state shares. A growing number of Chinese institutional investors are also looking for ways to diversify investments and win bigger returns. But those factors could be offset by any weakening in global demand for Chinese goods, and a resumption of initial public offerings. But with the economy chugging ahead at 10 percent growth last year and 9-plus expected in 2006, hopes are now high for a long-awaited turnaround in the new year. Based on our latest field trip to China, Chinavestor.com expects The9 Ltd. (NCTY) to report a nice surprise. On the other hand, we did not see much activity of Shanda’s line of products and expect the battled game and home entertainment developer to slip. To access latest Newsletter and other research content, please register!