Q&A: What China’s hot VC values mean for equities

A prominent investor in Asia equities talks about over-valuations in China’s VC scene as well as Asia’s potential for higher dividends.

Maple-Brown Abbott’s Geoff Bazzan has been investing in the Asia-Pacific region for over 20 years and the current rush into China venture capital investments puzzles him.

The Sydney-based investment management firm’s head of Asia-Pacific equities can’t figure out why so many investors are willing to pay high valuations for many illiquid assets.

“There might be the odd tenbagger that one will find,” he said during a telephone call with FinanceAsia, but exiting an investment at 10 times the initial cost is tougher when “valuations are far more extended, or premiums are much higher, in the unlisted space.”

Buoyed by record-shattering funding rounds for ride-sharing company Didi Chuxing and news aggregator Toutiao, total investment in China in the three-month period to June-end increased by more than 200% to $10.7 billion from $3.5 billion in the first quarter, according to a report by accountancy firm KPMG earlier this month. 

All the more reason why Bazzan believes it is better to invest in public markets, where there are rich pickings and a wider selection of companies to choose from.

Once index provider MSCI includes Chinese A-Shares in both the regional and global benchmarks from June next year there will be more stocks listed in the Asia ex-Japan region with a market value greater than $1 billion than in Europe and the United States combined, according to research by Maple-Brown Abbott. 

Add into the mix the potential for higher dividends and he is bullish on equities in Asia.

“We think the potential for dividend growth in Asia is very high,” he said, citing a number of factors including strong balance sheets, rising free cash flow yields, and recovering earnings. 

Coal producer China Shenhua jumped by 20% after announcing a special dividend in March. Also, Samsung's shares surged to a record high after the Korean conglomerate pledged to raise its 2016 dividend by 36% year-on-year in November.

Here are edited excerpts from the interview:

Q. How do you account for policy risk in Asia?

A. We’re cognisant that policy risks can have a big impact on the outcome of investments in Asia, no doubt about it. We do seek to take advantage of that where we think sentiment has been unduly depressed or inflated.

India before the election of [Prime Minister Narendra] Modi was a good example of that, or in China during the first quarter of last year when everyone was expecting the Chinese economy to fall off a cliff and we were buying industrial companies on discounts to book value or single digit P/Es, as if they were going out of business and that was clearly unrealistic.

Q. What concerns you about using Stock Connect?

A. As bottom-up stock pickers, the impediment to date has just been more attractive opportunities elsewhere in Asia.

We still look back to the experience of 2015 [when Chinese A-shares crashed] and are cognisant of the risks that presented themselves during that period. Indeed, something like 5% of all A-share companies remain suspended from trading.

Further, the market remains heavily dominated by retail investors and with turnover in [mainland China] many times that of the rest of Asia, it is a very much a momentum-driven market.

Q. How do you view dividend payouts across Asia?

A. We think the potential for dividend growth in Asia is very high.

In many respects, Asia is uniquely placed because you’ve got very strong balance sheets, rising free cash flow yields, and recovering earnings, coming off a fairly depressed cyclical downturn over the last few years. Yet your starting point in terms of payout ratio in Asia is almost half that of the rest of the world.

Historically companies in Asia have typically preferred to invest for growth rather than pay dividends. There hasn’t been pressure on them from shareholders. But that appears to be changing, with some notable examples in recent times such as Samsung or even Chinese [state-owned enterprises] such as Shenhua or Sinopec.

We’ve seen increased payout ratios in a range of companies. That’s entirely consistent with slower [economic] growth. In a slower growth environment [company] boards are becoming less focused on capex, in favour of free cash flow generation and total returns to shareholders.

Q. How do you view the valuations in Asian alternative markets right now?

A. Our sense is that the venture capital and private equity space in Asia remains pretty hot. Whilst we are not active in those markets, we are interested in non-listed transaction multiples in terms of what that could imply for listed stocks and of course the [initial public offerings] pipeline.

We’re often bemused that investors will tie up money at a higher fee, buying more expensive assets with far less liquidity than you could buy in public markets. You’re basically paying a premium for illiquidity, which doesn’t seem logical.

We use what’s going on as a sanity check for what we’re buying in listed markets, and our view would be pretty firmly that listed equities are far more attractive than the unlisted space.

There might be the odd tenbagger that one will find, but generally, my sense is that valuations are far more extended, or premiums are much higher, in the unlisted space.

The only alternative nature of these investments is often that they’re unlisted and untested. In weak markets, or when valuations decline, not having to mark them to market is obviously also perceived as a positive.

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