China's IPO debacle

The problems that Chinese privatisations are having in the international equity markets are political, not corporate

The world's most populous country is having the worst possible time selling its companies to international investors.

Last year, China National Offshore Oil Corporation (CNOOC) pulled its $2.5 billion IPO just 36 hours before launch. This month, PetroChina only just managed to launch its downsized $3 billion IPO to international investors despite more than 50% of the issue being placed with strategic investors such as BP Amoco and various Hong Kong property tycoons. PetroChina was also priced right at the bottom of the indicative price range.

CNOOC and PetroChina tried different IPO strategies - CNOOC went for a relatively high valuation and failed to sell the deal. PetroChina went for a low valuation, and sold the deal cheaply. For CNOOC the fear was that it was overpriced. For PetroChina the fear was that it would get cheaper in secondary market trading.

The relative failure of both strategies shows that it is not the underwriters that are to blame for the deals' performances.

Indeed the main problem with these IPOs is not the companies themselves, but the country that refuses to relinquish control over them.

China has a serious PR and IR problem. It makes no excuses that it runs its companies for the benefit of the state (ie, the communist party) and not for its shareholders. This causes immense difficulties for the companies and their underwriters trying to sell the stock into the market.

Exposing the fallacy

Government officials contradict each other in investor roadshows. They also maintain an air of arrogance towards investors, believing they will be falling over themselves to get a chance to own Chinese government-owned companies. The CNOOC and PetroChina deals vividly expose the fallacy of this belief.

What the Chinese leadership fails to realize is that if it wants the support of the international capital markets then it has to play by the rules. And rule number one is that shareholders come first.

Shareholders do not have the same interests as political leaders. They want companies to have a clear strategy that shows where shareholder equity is being spent and how those investments will improve returns on equity. This requires a commitment to transparency that the Chinese government seems unwilling to make. It also requires running companies in a way that might not be in the interests of the communist government.

But those are the rules. And what the CNOOC and PetroChina deals show is that investors are not going to make many more exceptions for Chinese companies.

Future privatizations such as China Unicom, Baoshan Iron and Steel, Heilongjiang Agriculture and Sinopec should expect an equally rough ride. Fudged accounts, political interference and unknowable use of proceeds are not the best way to entice investors into your company.

Perhaps one could argue that these companies with their Old Economy feel are the wrong companies for China to use to spearhead an international listing campaign. But the heavy hand of government is stifling the New Economy Chinese listings as well.

Obtuse rules banning foreign ownership of media content are forcing Chinese internet portals such as Netease.com and Sina.com to go to the international equity markets with bastardized corporate structures. These companies have had their core Chinese content stripped out of them before being sold to international investors.

Potential shareholders in these companies will not own the most valuable part of the business. This is not a recipe for success. It remains to be seen if investors will make exceptions for these companies "because they are from China".

It seems that there are many other internet companies out there where the shareholders actually own the companies they are buying into and have a say in how they are run. And given the recent tech sell off, these companies are cheap. If the Netease.com or Sina.com IPOs fail to fly, you will not have to go far to see the reason why investors steered clear.