Photographer: Brent Lewin/Bloomberg

Stock Buybacks, China Style: Get Your Workers to Buy Shares

Updated on
  • Employees urged to invest with executives insuring losses
  • More small caps employing the practice after market rout

Small Chinese companies have found a way to boost their stocks without buying a single share.

After being battered by the recent slump in mainland equities, cash-strapped small caps are turning to their employees, publicly urging them to buy company shares on the promise they’ll be insured from losses by executives, usually the chairman.

At least 23 companies -- most of which are listed in China’s southern technology hub of Shenzhen -- have offered so-called loss-free pledges in June, nearing levels last seen during the depths of the market crash in 2015. It appears to be paying off, with shares jumping an average of 5.6 percent on the day or day after the pledges were announced.

A uniquely Chinese take on the equity buyback, loss-free pledges can be a lifeline for companies with few other options, according to Credit Suisse Group AG. Workers who buy shares in their employer must hold them for 12 months in order to be compensated should the investment incur a loss, filings from a number of the companies show. Ice-making equipment maker Fujian Snowman Co. touted the “investment value” of its shares -- down 30 percent in 2017 -- in a statement to the exchange about the loss-free pledge offer.

“Some shares have fallen to near levels that could prompt margin calls or liquidation by creditors, putting a great deal of pressure on stockholders and executives,” said Li Chen, a Hong Kong-based strategist focused on mainland equity markets for Credit Suisse. Loss-free pledges are a “smart move,” he said, as they “send a positive signal and revive investor sentiment.”

Prolonged stock declines are of particular concern for small caps, which often have investors or management pledging their holdings as collateral in order to gain financing. In one example, the controlling shareholder of Eastern Gold Jade Co. -- a Shenzhen-based jeweler which said Tuesday that it was offering the pledges -- had 97 percent of its holdings, or 53.9 percent of Eastern Gold’s total, used as collateral.

No Cash

Shenzhen Composite Index members’ free cash flow, the amount left over after they’ve have paid their bills and made investments, was the weakest in the first quarter since Bloomberg began compiling the data 14 years ago. It’s been negative for four out of the past five quarters, with companies not able to generate more cash than they spend.

Loss-free pledges have caught the eye of Shenzhen’s exchange operator, which is demanding more details, the Securities Times reported late on Thursday, triggering declines Friday in most of the equities which have offered the pledges this month. The China Securities Regulatory Commission didn’t immediately respond to a fax seeking their view on the deals.

Read more: China Firms Insuring Staff Share Losses Fall as Bourse Weighs In

The pace of loss-free pledges picked up this week, after the 23 firms -- each with a market value below 20 billion yuan ($3 billion) -- fell at the start of June to near their cheapest level relative to the Shenzhen Composite in two years. At least six announced pledges in a single evening Tuesday.

‘Very Clever’

That’s good news for speculators, who are attracted to the equities because short-term gains are “almost guaranteed,” said Yin Ming, vice president of Baptized Capital, an asset management firm overseeing 200 million yuan of investments in Shanghai.

“Management at these companies will strive to keep share prices above key levels, effectively setting a floor for the stock,” he said. “They are very clever to have discovered this method, which requires nothing more than a verbal assurance to the market. People seem to be buying it, for now.”

But it’s not a solution for everyone. Anhui Deli Household Glass Co., a manufacturer based in one of China’s poorest provinces, slid by 5 percent -- the daily limit for companies subject to de-listing warnings -- on Friday, the day after offering its pledge. The company was warned by the regulator in April after posting two years.

Hao Hong, chief strategist at Bocom International Holdings Co. in Hong Kong, isn’t a fan of the loss-free pledge. It’s just a quick fix that inflates valuations to a level that eventually comes back to haunt the companies, he said.

The 23 companies that have offered the pledges this month trade at an average 85 times reported earnings, well above the Shenzhen Composite’s valuation of 27 times, data compiled by Bloomberg show. Among them are firms which also tapped their employees back in 2015, namely Shenzhen Fenda Technology Co. and Hunan Kaimeite Gases Co. Both stocks are down about 40 percent over the past two years.

“Such guarantees are pointless,” said Hong. “Instead of shoring up stock prices, what the companies should really do is beef up their corporate management.”

— With assistance by Amanda Wang, Sofia Horta E Costa, Feng Cai, Tian Chen, and Amy Li

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