China United IPO: A ray of light for mainland institutional investors?

Domestic investors are used to watching China''s best assets listed abroad. China United''s IPO could signal a change. But the number of good companies is still limited.

Chinese Institutional investors must be delighted and amazed they can finally invest in a company with some resemblance to a blue chip, despite China United's problems in rolling out the controversial CDMA technology.

China Unicom shares are expected to start trading in the run-up to the China's national day holiday on October 1. The share offering is the second largest in the history of the domestic markets, following China Petroleum and Chemical Corp's RMB 11.8 billion ($1.4 billion) offering last year. China United plans to raise RMB 11.5 billion from the operation.

Stock markets in China are notorious for their motley collection of small to medium enterprises in sunset industries. The government has been using the stock market as a way of subsidising large numbers of inefficient enterprises. The normal technique has been to sell one third of the company and let the company play, sometimes literally in the casinos of Macao, with the proceeds.

That makes it difficult for China's institutional investors, recently created by the government to find stocks with the necessary returns. The vast majority of the listed companies show very little resemblance to the expected national GDP growth figure this year which is expected to reach 7.6%.

Since China launched its first closed-end fund four years ago, and domestic mutual fund more than a year ago, the number of funds available has grown to 64, with 19 fund management companies having more than RMB 100 billion in assets. These institutional investors are considered key to imposing discipline on listed companies and in generating pension and insurance revenue to compensate for the government's desire to withdraw from these burdensome tasks.

Many commentators have expressed pessimism at the after market performance of China United. The combined daily turnover RMB 70 billion on Friday is only around 10% of the turnover at the end June, example.

Yet the presence of such a large counter, although its sheer size could overwhelm the market in the short term, should hopefully raise the profile of the stock market, say local managers.

"Look at the Hong Kong market - it gets so much attention and cash from western money managers largely because of one counter, banking giant HSBC," says one local fund manger.

"Hopefully, our stock markets will continue to see IPOs of good companies, instead of them all listing overseas. That should attract more money to the market."

Still, it seems that with the reports that the Mainland-listed entity will have to absorb the loss making pager units of the Hong Kong-listed entity China Unicom, mainland-listed stocks will continue in their role as whipping boys.

That will put further pressure on Chinese fund managers who do not have the risk management tools and derivatives structures to take a flexible approach to their investments.

"If you look at the way the domestic market actually functions, and the amount of price ramping and price manipulation that goes on, the public nature and size of the funds makes them counter productive," says one fund manager.

Fund managers are also struggling to cope with the China's fragmented share ownership structure. Since the government wanted to maintain its iron grip on corporate share ownership in the early days of listing state-owned companies, on average one third of the shares were categorized as non-tradable government shares, while another one-third was categorized as legal person shares in the hands of government-affiliated organs such as other state-owned enterprises.

The listed shares trade at a much higher prices than the other two categories, since for many years investors assumed that the government would not sell down its direct stake in the companies. With the government now indicating an increasingly urgent desire to monetize its holdings, investors are seriously spooked, leading to the sharp correction in the China's stock markets in the past year.

One attempt to solve the different valuations of the shares has been to sell the legal person shares to foreign investors. For example, Shenzhen Development bank is said to be planning to sell 15% of itself in the form of legal person shares to a foreign investor. Yet local managers say that while foreign investors may be interested in taking a stake in such a strategic area as the domestic banking industry, many of China's listed companies in sunset industries, will not attract the same attention, especially if all the foreign investors can get are the controversial legal person shares.

These can be traded, but not as easily as the free float shares, and require government approval. Until the government announced a date on which the legal person shares can be converted into regular listed shares, estimate analysts, foreign investors will only be willing to buy the legal person shares at a large discount to the government's stated aim of selling at not less than 20% over the shares net asset value. This is especially true while the Chinese currency remains unconvertible on the capital account.

For many years, the Chinese government has been following the laudable aim of listing on foreign stock markets to force its companies to shape up. In the long run, however, it can not rely on foreign markets to take over what is in fact the government's responsibility. Chinese investors need good companies to invest in. Listing companies in Hong Kong or New York where they are beyond the reach of domestic fund managers should only be a temporary solution.

Share our publication on social media
Share our publication on social media