Reform in need of time to fix overpriced IPOs

Drugmaker

Aosaikang, a Nanjing-based anticancer injection maker, suspended its IPO on Shenzhen's ChiNext board on Jan 10, the day its online offering was due to begin. "As the scale of the offering and old share transfer were relatively big, the issuer and major underwriter, China International Capital Corp Ltd, decide to suspend the offering," said the company.

Just one day before, Aosaikang announced that it planned to issue 55.466 million shares at 72.99 yuan apiece. The sale would value the drugmaker at 67 times its 2012 earnings compared with the average 55.3 times for its peers listed on Shenzhen's growth enterprise board. What's more, 43.6 million stocks of the offering are old shares released from its major shareholder, Nanjing Aosaikang Investment Management Co Ltd, which would have pocketed 3.18 billion yuan. The company to be listed would have raised only 866 million yuan.

Although the commission has denied any heavy-handed intervention, it is widely believed that Aosaikang's surprising move was based on the regulator's intervention.

"The Aosaikang IPO was stopped obviously because of its sky-high offering price and out-of-range P/E," said Kenny Tang, general manager of AMTD Financial Planning Ltd. "In order to bring down the share price, the commission allowed a reduction of the old shares to boost the stock supply on offer. But the regulator's approach is not comprehensive.

"However, what's different this time is that the commission intervened immediately when they found things were wrong. That means they are serious about bringing down issue prices. Rules that suit developed markets don't necessarily suit China," he said

"It's not the right time yet. The reform has to be carried out gradually. At this moment, administrative intervention is still an effective tool." He adding further moves from the authority are expected to fill the regulatory loopholes.

"The Aosaikang scenario is an independent event. It wouldn't change the fact that, ultimately, the pricing power will be given back to the market," said Chen Yuanfei, chief analyst of the finance sector at Haitong International Securities Group Ltd.

"The suspension of the Aosaikang IPO looks like the commission is eating its words about liberalizing the IPO market. But we are at a very early stage of the change and there are bound to be relapses. The key is to improve the regulation system," she added. "The reform needs three to five years to be carried out. So investors deserve more time to mature."

On Dec 30, the equity market watchdog issued a package of new IPO rules to kick off the A-share market reform. The pack features stricter rules on information disclosure and emphasizes the liberalization of the market. In addition, it vows to bring down the issuing prices and protect the interests of individual investors.

Following the new rules, the authority resumed the IPO pipeline, which had been stopped since September 2012. In less than two weeks, up to Jan 9, the commission approved 51 listing applications. This week, 33 companies have been scheduled to debut. More than 700 other companies are still in line for the green light.

"The IPO rule reform is long-term positive to the A-share market, because the trend is now clear that the mainland capital market will apply a registered system for listing," said Benson Wong, partner of PricewaterhouseCoopers Ltd.

"As the A-share market liberalizes, the average price-to-earnings ratios of IPOs will decline. We see the valuation gap between the mainland and Hong Kong stock markets narrowing now. Because the A-share market tends to provide similar protection to investors, and the supply of new stocks is huge, the share prices of the two sides will get closer."

Analysts from Deloitte China also said they believe the new rules will settle the overpricing problem of IPOs on the mainland stock market.

"One of the factors behind the high listing price is the shortage of supply. Because China is a relatively closed capital market, idle money has to be used at every opportunity. New stocks are very attractive to people," said Anthony Wu, China A-share capital market leader of the national public offering group at Deloitte China.

"The registered system will lead to a large amount of new stocks, which in turn can ease the pressure."

It promised in the commission's Dec 30 rules that the authority will make its decision within three months after an IPO application is filed. "That should significantly speed up the application process," said Wu, adding there used to be no limit on how long the authority took to deliver results.

"Small cases took roughly six months, and there was no surprise if bigger caps had to wait for 18 months or more."

Meanwhile, the new regulation encourages major shareholders of companies on offer to release old shares in order to make sure demands for new stocks are met.

"If there is over-subscription, the company must offer more old shares. That can ease the pressure in the supply of new stock," said David Xian, an audit partner at Deloitte China.

Apart from that, under the new rules, the amount of new stocks retail investors can subscribe to is linked with the valuation of shares they own in the secondary market. "Individual investors will be less active in subscribing to new stocks," said Xian. "For those who used arbitrage in IPOs with all their capital, the good days are over. Now a large proportion of their cash is trapped."

Dick Kay, co-leader of the national public offering group of Deloitte China, said that less participation by retail investors in subscriptions will help to solve the overpricing problem because institutional investors are more reasonable.

"Retail investors take a more speculative approach. They are not capable of pricing a company. Investing in the equity market requires a lot of research, which should be left to the professionals," he said.

However, AMTD's Tang said that Chinese institutional investors are not reliable partners in the reform, either.

"The Aosaikang event shows that the mainland market is full of short-sighted investors. Even institutions are eyeing fast cash. That's no good for stabilizing the valuation of A shares. People hoard small caps. Big names are left aside," said Tang, adding the maturity of a market depends not only on its regulation system but, more importantly, on the quality of participants.

"What the A-share market needs is long-term investors," he said. "It's helpful that the recent financial reform raises insurance companies' exposure to the stock market. The IPO reform also gives priority to the Social Security Fund and public offering funds in new stock subscriptions. In the future, the regulator should bring in more long-term capital such as pension funds to stabilize the market and build up confidence."

However, Haitong International's Chen said that those who get burned learn fast. "The authority should have allowed Aosaikang's IPO proceed as planned," she said.

"Some investors just have to learn their lesson the hard way. There should be several occasions when the market sees new stocks fall to the limit on their debut. Only when people realize buying new stocks is not risk-free will they start to be rational about IPOs."

Contact the writer at emmadai@chinadailyhk.com