Hong Kong's Growth Enterprise Market, the six-month-old board created to help unprofitable companies raise public money, is taking the biggest beating of its short life. It fell 38% in the last month and analysts predict it could fall further as poor distribution of many companies' shares exacerbates the broader flight from technology stocks.
Shares of more than half the 23 companies listed on GEM have plunged below their issue price. While analysts attribute part of the decline to the world-wide bursting of the internet bubble, critics are increasingly pointing the finger at GEM regulators and at the investment banks which underwrite the listings.
The tendency of newly listing companies to place all or most of their shares in the hands of a limited number of investors has helped drag the GEM down further than its US counterpart, the Nasdaq. In the past month the GEM has underperformed the Nasdaq by 16%.
"The problem is that with the market downturn people are starting to question the practice of placing of shares in an IPO to a limited number of people," says Herbert Lau, head of research at Celestial Asia Securities Holdings in Hong Kong.
Many companies place shares with institutions in the hope those institutions will hold them for a substantial period. They can get a shock when those shares are sold on the first day of trading.
One such company is iSteelAsia.com, an online steel exchange which listed on GEM on March 20. In an interview several days before trading began, Drina Wan Yue, the company's chief operating officer, said the company was confident its shares would be safe in the hands of small but committed group of select investors.
"The shares have been placed with financial institutions who have a long term interest to hold our shares and we feel very strongly that they will hold," she said.
On their first day of trading the shares fell 27% to 79 cents from HK$1.08.
"The institutional investors are supposed to be the lynchpin for these companies and they're not coming through," says Yuen-Kang Chau, head of HKGrowth.com, a company that provides information and market analysis on the GEM. "People give them way too much slack. They've been out there flipping from day one."
There are signs the stock exchange is beginning to notice. In April regulators began investigating trading in Digitalhongkong.com, an internet company majority-owned by main board-listed Champion Technology. Digitalhongkong.com's shares rose as much as 228% to HK$3.35 from HK$1.02 in the days following its March 17 listing. They have since dropped back to around HK$2.00. Hong Kong's Securities and Futures Commission said it was concerned that 97% of the 25.2 million new shares issued by the company were placed with just six investors.
The exchange also announced in April that a director of hongkong.com breached GEM rules by dealing in the company's shares prior to the release of the company's quarterly results.
Three main players
GEM accounts for about 5% of the Hong Kong Stock Exchange's total market capitalization. Yet it accounts for between 10% and 20% of its turnover. That would seem to point to an active market, but it obscures the fact that most of that turnover is generated by three companies.
In March, according to GEM statistics, tom.com, an internet company backed by tycoon Li Ka-shing, accounted for 36% of the market's capitalization of HK$86,726.35 million. Sunevision, an IT infrastructure company, accounted for 30%, while hongkong.com, an internet content provider, accounted for 30% - for a combined total of 96%.
In the same month, tom.com accounted for 48.1% of the market's HK$33,677.80 million in turnover. Hongkong.com accounted for 21% and Sunevision accounted for 20.3% - for a combined total of 89.4%.
The same three companies accounted for a combined 77% of the 4,406.50 million shares traded in the same period.
Relaxing the rules
The limited distribution of shares by underwriters, and the dubious quality of some of the companies listed, has been facilitated, some argue, by the GEM's increasingly relaxed listing rules. "It seems that the approach the GEM listing committee and the stock exchange have taken in running GEM encourages the kind of flotation we've seen so far and points to a short term attitude of maximizing the number of listings at the expense of destroying the credibility of the market over the long term," says David Webb, editor of webb-site.com, an online source of financial information. Webb was one of the committee members in charge of drawing up GEM's original regulations.
In March, the stock exchange said it would reduce the financial track record requirement from two years to one year and the share lockup period, with certain provisos, to six months from two years. "If the original criteria had been enforced a lot of these stocks wouldn't have got listed," says Webb.
Dr. K.S. Lo, chairman of the GEM listing committee, which vets applicants, defends the relaxation of the rules. "Relaxing some of the rules is just to put us in line with other exchanges, like Nasdaq, which has no lockup period at all," he says. Lo concedes, however, that the exchange is looking into the issue of market liquidity and the placement of shares.
Still, despite its growing pains, some analysts predict the GEM will eventually find its feet. "GEM fulfills a useful function and eventually will gain some degree of respectability," says Marc Faber, managing director of fund management company Marc Faber Ltd. "In the end the investors will become educated and the market mechanism will take care of itself."