Newsletter July 2005

Mixed Chinese IPOs teach lessons   Mixed Chinese IPOs on the Hong Kong Stock Exchange set tone for new offerings. Let’s wrap up June IPOs by  using headlines of major publications. 6/30: COSCO holdings makes weak debut on Hong Kong Market 6/23: Bank of Communications makes solid debut on Hong Kong Stock Exchange 6/16: Minsheng delays Hong Kong IPO to Q3 6/15: World’s biggest IPO this year has lackluster debut on Hong Kong Market 6/13: China Construction Bank given hefty tax break to help bolster its balance sheet, as the government prepared the bank for a planned $5 billion IPO. The picture is not too rosy for IPO hunters. However, established firms are still on the run to establish strong presence in China. Pulling headlines again, 6/30: Telefonica enters China market with Netcom stake 6/17: Bank of America investing $3 billion in Chinese bank. As it looks to us, private investors are still considering China as an emerging market while large multinational corporations are eager to find ways to establish dominant presence in the world’s most dynamic market. So what does this teach to individual investors? First that China is still a difficult market. Even though the government is planning to spend billions of dollars to boost the country's ailing stock markets, many analyst believe that any bailout would provide only temporary help. The core of the problem is that non-tradable shares, mostly owned by the state, account for around two-thirds of China's stock market capitalization. Second lesson is that investors has to be able to separate the darlings from the dogs. No one can assume that just because China is growing fast, any Chinese company will do so. Investors have to sober up finally, after lessons learned from 2004 tech IPOs. Most of those stocks trade under their IPO price as we speak. Third, China is still an extremely lucrative market as it is luring billion of dollars however investors have to build sophistication more than ever to make a China entry successful.   The fundamental problem of Chinese stock markets   Government-held shares, the legacy of a centrally planned economy, comprise two-thirds of market capitalization in China and have weighed on bourses for years. The Shanghai and Shenzhen stock exchanges, where about 1,400 state-owned companies are listed, are each down 40% to 50% from the highs they reached in 2001. China's stock markets, founded in the early 1990s, were created mainly as a vehicle to raise funds for state-run companies. In recent days, the government has announced other market boosting measures, such as slashing the proportion of taxable income from stock transactions. According to rumors the government would soon start trial share reforms for all listed companies appeared to overshadow such news.  Although the state shareholdings are a chronic headache for China's market regulators, the lack of investor confidence stems from even more fundamental problems, such as widespread abuses by brokerages and the dubious quality of the companies listed on the markets. But some analysts say that turning to a bailout fund could make the situation worse by encouraging investors to sell more of their stocks, saddling the government with huge additional losses.   Yuan Answers?   June 2005 was a month when speculation about the Yuan's revaluation intensified. It looks like the U.S. Treasury plays the good cop, relying not on threats but reasoned economic argument: Let your currency rise, it tells the Chinese, not for our sake but yours. Flexibility is your friend, the market your ally.  Act like the economic superpower you have become. The Commerce Department plays the pragmatist: Free trade is a nice slogan, but you Chinese know that slogans aren’t policies. What matters is jobs.  Either find a way to retain your exports of clothing and textiles to us, or we will find a way to block them. If you don’t like it, sue us in the world-trade court. The U.S. trade representative prefers the high ground: Steal our factory jobs if you must, but stop stealing our ideas, the intellectual property that is our best hope of prospering in the global economy. The Pentagon flexes its muscles. None of this soft “China is our ally” message from Defense Secretary Donald Rumsfeld. Without as much as a nod to his own growing arms budget, he went to Asia mid June and asked pointedly and publicly: “since no nation threatens China, one must wonder...why these continuing large and expanding arms purchases?” The Congress, keenly aware of American’s anxiety about losing jobs, plays the heavy: You Chinese are “cheating,” some, though not all, members of Congress shout. If the Bush administration doesn’t do something about it soon, we will. How do you say “tariff” in Chinese? But many think that China will not want to be seen as buckling under U.S. pressure: Public demands, under this view, will only make the Chinese take longer to move to a flexible exchange rate. Presumably U.S. officials know this. So why are they pushing?  A cynic might hope that the push is not a response to misguided political pressures, but is instead a devious attempt to prolong the enormous benefit  the U.S. derives at China’s expense from the fixed dollar-yuan rate. To highlight the benefits, let’s think about this. If China’s currency is undervalued by 27%, for argument’s sake, U.S. consumers have been getting a 27% discount on everything made in China, while the Chinese have been paying 27% too much for Treasury bonds. Revaluation would end the Chinese fire sale. Americans will pay more for everything, from electronics to garments. Other global investors will buy up U.S. bonds the Chinese no longer want, but the Treasury and the public will have to pay higher interest rates. Looking into different sources and analysis, the one we found being the most profound is from the Asian Development Bank. It says, “A revaluation of the Chinese currency would have limited impact on the U.S. trade deficit, but it would help cool China’s overheating economy.” A yuan revaluation would also increase the trade surplus of some Asian countries,  according to the study. Argument being that a reduction of U.S. imports from China would likely lead to an increase of imports from other Asian countries. Either way, China will continue to grow into an economic superpower while the U.S. has to implement mutually acceptable practices.   Oil battle sets showdown over China   Cnooc’s offer for Unocal raises stakes in conflict over Sino-U.S. ties. The $18.5 billion bid by a Chinese oil company, Cnooc Ltd., to buy the American energy company Unocal Corp. suddenly has raised to the boiling point a long-simmering question: Should the U.S. government move more aggressively try to curb China’s rising power? Federal Reserve Chairman Alan Greenspan’s view may be the best approach: “It is essential that we not put … our future at risk with a step back into protectionism”. Will see.   New Capital Flowing Into Chinese Stock Market   Transactions on the Shanghai and Shenzhen stock exchanges have been considerably heavier over June, while the stock indices rebounded and refused to hit new lows again. It seems that new capital was flowing into the stock market, partly from the real estate market. Recently, the Chinese government is making every effort, including giving favorable taxation treatment to promote healthy and steady development of the capital market and rally the stock market that has slid all the way by more than four years and lost more than 50 percent in stock indices. With regard to the stock market, the Ministry of Finance and the State Administration of Taxation recently took two tax concession measures, following the reduction of stamp tax on securities trading several months ago. The two ministries announced on June 13 decisions to exempt some equity transactions from stamp tax and dividends from corporate and personal income tax in an effort to boost the bearish stock market. The endeavor also included to tax only half of dividends for individual investors. Under the new tax policies, the public investors on the Shanghai and Shenzhen stock markets will pay several billion yuan less in income taxes on dividends every year. Statistics show that 759 out of the 1,376 companies listed on the two bourses offered cash dividends for the year of 2004, totaling 76.9 billion yuan. According to the new tax policy for dividends distributed to public investors, the taxable income will be halved to 38.5 billion yuan, which means tax concessions of 7.69 billion yuan at the currently popular 20 percent dividend income tax rate. China's stock market has not been attractive to long-term investors fundamentally because of its low yield. In the past, the average annual yield from few stocks was higher than that of deposits at banks for the corresponding periods. But the situation has begun to change and is sure to turn for the better in the future as the problem is now concern of the authorities, the listed companies and the investors. In 2004, a total of 65.4 billion yuan was raised from the Shanghai and Shenzhen stock markets, while the companies listed on the two bourses distributed 76.9 billion yuan cash dividends. This was the first time to see more distributions from listed companies than the money raised by listed companies from the Chinese stock market. To access latest Newsletter and other research content, please register!