How ChiNext Helps China's Small Companies Thrive

Han Lingjing remembers pleading for financing from China's state banks. The board secretary of drugmaker Tianjin Chase Sun Pharmaceutical says she always heard the same line from loan officers: "You need to have tangible assets as collateral." Translation: no bank money for risky companies. "We felt so helpless," she says.

No longer. Just over a year ago, the ChiNext stock exchange, designed for startup companies, opened for business. Chase Sun was among the first to sell shares to the public, pulling in $113 million when the exchange first opened. Those proceeds allowed it to diversify into new drug lines, lessening its reliance on Xue Bi Jing, its blockbuster drug used to help treat SARS. Third-quarter revenue was up 66.3 percent over the same period last year. "ChiNext gives a pair of wings to a company like ours," says Han, 42. "Now we can fly."

Government regulators created ChiNext, which operates as part of the Shenzhen exchange, to make it easier for companies in what China Securities Regulatory Commission Chairman Shang Fulin has called "strategically important emerging industries" to gain access to China's vast pool of savings. Today, 141 stocks trade on ChiNext, which requires companies to have net assets of 20 million yuan ($3 million), two consecutive years of profit, and cumulative profit of 10 million yuan. The Shanghai exchange requires net assets of 30 million yuan, three straight years of profit, and total earnings of 30 million yuan.

In the 12 months after ChiNext opened, on Oct. 30, 2009, 134 companies raised almost $15 billion through initial public offerings. Over the same time, there were only 24 IPOs on the Shanghai exchange. "History will view it as a big turning point for the development of the country," says Singapore-based Mark Mobius, who oversees $34 billion for Templeton Asset Management.

Fostering the growth of smaller companies is part of Beijing's effort to reduce the country's reliance on exports of basic manufactured items and encourage the creation of higher-value goods and services. Twenty years after stock trading began in Shanghai, China's markets are booming. Its companies have a combined market value of nearly $4 trillion, second only to U.S. stocks. Yet when it comes to listing, regulators favored big, state-owned companies such as PetroChina (PTR) and Industrial and Commercial Bank of China and tended to ignore enterprises bubbling up out of the private sector.

Regulators hope that ChiNext will spur investment from private equity and venture capital firms, because it makes it easier for the companies they back to go public. Already, 59 percent of companies listed on ChiNext as of October were backed by venture capital or private equity firms, according to research firm ChinaVenture. "ChiNext has speeded up everything," says Li Xiaojun, a partner at Beijing-based venture capital firm IDG Capital Partners.

One risk for ChiNext is that its explosive takeoff has driven company valuations to 66 times earnings—about three times the average for Chinese stocks. "The market's still young, it's still flawed, and with an excessive speculative frenzy," warns Beijing-based Fred Hu, former Greater China chairman for Goldman Sachs (GS) and founder of advisory firm Primavera Capital Group. Also a concern: a flurry of share sales by senior managers of newly public companies as lockup provisions expire. Xu Xiaonian, a professor at the China Europe International Business School in Shanghai, says the market is a "tool for the powerful and the rich to cash in." ChiNext tightened rules governing share sales by top managers on Nov. 4, prohibiting executives from selling their shares for at least 18 months after the company's initial public offering, up from 12 months.

Others point out that China needs the banking sector to be more responsive to emerging businesses. While companies raised $79 billion in stock sales for the 12 months through October, new bank loans over roughly the same period totaled $1.13 trillion, with most going to state-run companies. According to an Oct. 4 report by Euromonitor International, small and medium-size companies get only 16 percent of all bank loans. "China needs to form smaller, private banks" more willing to lend to young companies, says Hong Kong-based Shen Minggao, Citigroup's (C) chief economist for Greater China.

Liu Zehui, executive director of Beijing-based private equity firm Legend Capital, thinks ChiNext is doing exactly what it was meant to do. "The ChiNext market has released the pent-up passion for innovation and entrepreneurship in China," he says. "It tells everyone that you don't have to have a powerful dad to get rich."

The bottom line: In its first year, the ChiNext market has fulfilled its mission of making it easier for startup companies to raise money.

With Frances Liu

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