China's Blowing Hot on Tech Stocks
Just as U.S. technology shares are losing air, China's planning to engineer its own boom.
Over the weekend, the country took a major step toward bringing U.S.-traded technology giants such as Alibaba Group Holding Ltd. and Baidu Inc. to the domestic market, via a trial program that would let them sell Chinese depository receipts. More remarkably, the China Securities Regulatory Commission essentially removed all profitability requirements for so-called innovative companies, with a brief announcement that ended at least a decade of market practice.
Such companies, deemed strategically important by Beijing, can go public if they have operating income of no less than 3 billion yuan ($477 million) in the most recent year and a valuation of at least 20 billion yuan, according to the regulator. But if a startup can't hit these numbers, it can still be listed as long as it "grows fast, owns independently developed and internationally leading technology, and has a dominant competitive position." The CSRC will decide whether an enterprise meets those standards.
It's a sharp turnaround for a regulator that has limited IPO issuance on concern that a flood of new listings would cause a repeat of the 2015 stock market crash. In the past, all firms wanting to go public had to show at least three years of profit.
In fact, the relaxation is a lot broader than it first appears. Areas considered innovative by the CSRC include: the internet; big data; cloud computing; artificial intelligence; software and integrated circuits; high-end equipment manufacturing; and bio-pharmaceuticals. Monies raised can also now be moved offshore, another unusual step.
With U.S. tech stocks tumbling, returning home promises riches for Chinese companies that are listed there. 360 Security Technology Inc., formerly known as Qihoo 360 Technologies Co., boasts a $43 billion market cap after being taken private in 2015 and going public in Shanghai in February through a reverse merger. Perfect World Co. is worth more than six times the $1 billion at which it was de-listed from New York in July 2015. The new-economy-heavy ChiNext Index has also held up a lot better than the Nasdaq Composite Index.
But as we've argued in the past, the change is fraught with roadblocks. Allowing Chinese depository receipts breaks two longstanding prohibitions: on variable interest entities, or VIEs, and multiple share classes, both of which are popular with overseas-listed Chinese tech companies. Baidu, JD.com Inc. and Alibaba all employ mechanisms that depart from the one-share-one-vote principle, and all are VIEs domiciled in the Cayman Islands.
Valuations may be another sticking point. The CSRC imposes an unspoken price ceiling of 23 times earnings for companies going public. Over the past year, the 100-odd firms that sold shares listed at an average of 21.5 times earnings, ranging from 9.9 times to 22.99 times, data compiled by Bloomberg show. One can hardly expect a hot startup to settle for such a low multiple.
The chances are that the CSRC will make exceptions, because it already has. Huaneng Lancang River Hydropower Inc. raised 3.9 billion yuan in December selling shares at 76 times earnings. The Shanghai IPO was the only exception to the 23-times rule -- and it's no accident that the company fits nicely with Beijing's clean energy drive.
To foster innovation, China is now breaking many rules. But at what cost? The country's notorious day traders will take the hint from the regulatory relaxation and pile in, until another bubble forms.
Beijing had better be ready to pick up the pieces.
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Matthew Brooker at firstname.lastname@example.org