Global Economics

Daqin Railway Jumps On China's IPO Train


Deals are getting done here, there, and everywhere in China as companies and banks rush forward with initial public offerings. Consider the gargantuan money-raising move by Bank of China, which raised $13.7 billion in Hong Kong and Shanghai in late May and July. And Industrial and Commercial Bank of China (ICBC), the country's biggest lender, has received government approval to raise $14 billion in a mega-IPO at those same two exchanges in October. Both offerings will surely place 2006 in the record books.

Those two deals alone exceed all the money raised by Chinese companies in 2005, when mainland companies attracted nearly $25 billion in IPOs, mostly out of Hong Kong. And it marks "the emergence of China as a serious factor in global capital markets," according to a worldwide survey by Ernst & Young released last month.

This year, equity-raising deals at China's two domestic exchanges in Shanghai and Shenzhen are also growing at a phenomenal pace, and with good reason: They are among the hottest bourses on the planet right now. The benchmark composite index at the Shanghai Stock Exchange is up 43% this year, while stock prices in Shenzhen have advanced a scorching 52% (see BusinessWeek.com, 7/5/06, "China's Torrid Domestic Exchanges").

HUNGRY TO BUY. Even Chinese rust-belt companies are getting into the act. On July 20, coal railway transport company, Daqin Railway, raised nearly $2 billion as investors figured China's massive energy needs and ample coal reserves suggested good times ahead. What's more, there could be a lot of secondary offerings in the pipeline for the Shanghai and Shenzhen bourses, analysts say. Air China and Aluminum Corp. of China and are expected to go forward with share offerings. China Mobile (CHL) is another possibility.

What's going on here? Several trends have come together to create a perfect storm of demand for Chinese shares. First, global and mainland investors alike are hungry to buy into the China growth story. China's economy grew an astonishing 11.3% in the second quarter, and while there are serious concerns about overheating inside China's $2 trillion-plus economy, investors seem to be brushing them off for now (see BusinessWeek.com, 6/18/06, "Is China Growing Too Fast for Comfort?").

REAL REFORMS.Another important development is the push by Beijing to clean up the domestic exchanges in Shanghai and Shenzhen. In the past, they have never functioned as normal markets. Corrupt insider deals turned off a lot of investors, as did government control of huge stakes in a lot of listed mainland companies that were essentially untradable. Now, financial authorities in Beijing have finally gotten serious about ending government ownership in mainland companies.

Reforms launched last August to convert $200 billion worth of these largely nontradable Chinese company shares into tradable shares have gone far better than expected. Some 80% of China-listed companies now have plans to make the conversion.

That had been a "great sword of Damocles hanging over the market," according to David Wolf, who runs the Beijing-based management advisory firm Wolf Group Asia. With market confidence improving this year, Beijing financial regulators in May also lifted a year-long ban on IPOs at the two domestic exchanges.

NARROWED GAP. Jing Ulrich, chairman of China equities at JP Morgan (JPM), also points out that ordinary Chinese, who control $1.8 trillion or so in household savings, don't have many choices where to park their cash. Bank deposits yield 2% or so, and property prices are pretty frothy in markets like Beijing and Shanghai. She also argues that even with the gains this year in Shanghai and Shenzhen, Chinese stocks are not that pricey.

The traditional valuation gap between the so-called H-share market in Hong Kong for listed companies based on the mainland and A-shares (yuan-denominated shares traded at domestic exchanges by local investors and government-approved foreign ones) has all but disappeared. Hong Kong-based H-share companies are trading at price-to-earning multiples of about 13 times forecasted 2006 profits vs. about 14 times for big, blue-chip A-share companies.

Ulrich screens out smaller, less attractive A-share companies to get that number. All these things combined are encouraging Chinese companies to raise new capital in Shanghai and Shenzhen. There seems to be plenty of demand.

"PRETTY GOOD PROXY." Meanwhile, foreign investors, who tend to gravitate to the H-Share market in China, are exhibiting an insatiable demand for China bank stocks. In a fairly effortless fashion, China Construction and Bank of China offerings raised more than $20 billion in all, and the same is expected of ICBC.

Why? Because of their size (China's top four banks control 57% of all lending in China) and business ties to every industry that matters on the mainland, these giant lenders "provide a pretty good proxy" for China's hyper-growth economy, notes May Yan, senior vice-president and a credit analyst with Moody's Investor Services in Hong Kong.

Thanks to the economy's white-hot growth and rising incomes, China's banking industry experienced more than 15% annualized growth in deposits from 2000 to 2005. Another big plus: China's interest rates, which are still largely regulated. China's current one-year interest rate of 5.85% is more than three percentage points higher than what Chinese banks pay out to depositors. That's a pretty comfy profit cushion (see BusinessWeek.com, 5/31/06, "A Golden Age for China Banks").

ANY LETUP? All this also explains why banks' stocks continue to perform well. Since their IPOs, China Construction and Bank of China both have performed solidly. China Construction's shares are up 43% since their debut in Hong Kong last October. Bank of China's stock has advanced 17% since it listed there in late May.

How long will this party last? Well, in 2007, there won't be any IPOs on the scale of Bank of China or ICBC, so money raised in volume terms likely will fall back. A boom-and-bust economic cycle would obviously dry up demand, as would a stock market bust in Hong Kong, Shenzhen, or Shanghai. For now, though, China's economy is operating at hyper-speed and global investors clearly want a piece of it.


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