New index highlights power of Chinese private sector

UBS Warburg is introducing an index tracking the performance of China''s listed private sector.

UBS Warburg has introduced the first index to cover China's private sector, the China Private Enterprise Index, also known as the ôP-Share Indexö. It reflects the performance of Chinese companies with controlling stakes held by individuals or families. Tracking the index's constituents reveals it has jumped 51.07% in local currency terms and 50.89% in dollar terms from January to August 1, 2001.

In contrast, the red chip index (Chinese companies incorporated in Hong Kong) has risen 1.49%, while the H-share (China-incorporated, Hong Kong-listed companies) index gained 22.88% for the same period.

ôWe introduced the P-Share Index because we think they can outperform the ex-SOEs (state-owned enterprises) listed in Hong Kong as red chips or H shares, which have generally shown poor ROE (return on equity)ö, says Joe Zhang, head of China research at UBS Warburg.

This is despite companies listed in Hong Kong being the cream of ChinaÆs public sector, including heavyweights such as telecoms companies China Mobile and China Unicom, as well as ChinaÆs oil majors Sinopec, CNOOC and PetroChina.

The weakness of the public sector is reflected on ChinaÆs domestic market, the so-called A-share market, which is closed to foreigners. Although valuations are considerably higher than in Hong Kong, due to huge investor demand and restricted supply, most of the companies are in various stages of restructuring. They are also blighted by notoriously opaque corporate governance standards and accounting methods, as well as poor ROE.

In contrast, P shares are fast-moving units, usually set up in the past four years by entrepreneurs with a good understanding both of the market as well as the regulatory environment.

The companies selected by UBS Warburg cover areas from TV and telecoms to food, agriculture and natural gas, and all of them also have foreign listings in Hong Kong, Singapore or on New York's Nasdaq. ôThese companies are in an ideal situation to exploit the weakness of companies in state-run sectors, which for several reasons are losing their grip,ö says UBSÆ Zhang.

In gas and liquefied petroleum (LPG) distribution, for example, P shares Xinao Gas and Wah Sang Gas could benefit from ChinaÆs move away from coal and coal gas for its energy needs by supplying the environmentally cleaner piped gas or LPG to millions of households and industrial or commercial customers.

Shandong-based PeopleÆs Food and United Foods are capitalizing on ChinaÆs huge consumption of pigs and chickens and moving in to fill the gap left by the collapses of state monopolies. Construction, real estate and the finance industry are other areas where private companies are moving in.

There are currently close to a 100 city-based small banks in China, mostly in private hands and doing business with the private sector, according to UBS research. In addition, in the brokerage business, Eagle Securities is a private-sector company and among the top-10 players in the sector.

The private sector contributes around 40% to ChinaÆs GDP, but has some way to go before it has the same commercial rights as the public sector, which previously had a total monopoly on crucial commercial activities such as importing and exporting as well as distribution. The private sector is also squeezed out when it comes to accessing financing. The private sector receives just 15% of loans, yet pays higher interest rates.

However, the government is clearly moving in the direction of allowing the private sector greater scope, partly to allow it to compete better in the wake of ChinaÆs entrance to the World Trade Organization, scheduled for January 1 next year.

In 1998, for example, the government provided export licenses to 1,000 private sector firms to counter the export slump and fears of a yuan devaluation prevailing at the time.

Still, Zhang warns investors dabbling in ChinaÆs private sector should be wary of its ôinherent weaknessesö and treat it as a venture capital project by investing in a basket of the shares in the hope that some will flourish.

Zhang said the management of P-share companies have little experience of international exposure, and tends to employ only friends and relatives in senior positions. In addition, they often perceive service expenses, such as marketing, to be an unnecessary drag on the bottom line.

But the move earlier this year by ChinaÆs top leader, President Jiang Zemin, to welcome private businessmen into the Communist Party is a powerful symbol of the rise of the private sector.