Tread carefully in China: there's a bubble in the making

published 31 October 2005

The Chinese government trumpets its ambitious programme of selling off stakes in state enterprises as a central plank of its economic reforms, says Dan Fineman in the Far Eastern Economic Review. But if that's the case, "China is in trouble". For instead of promoting modern management practices, deepening capital markets and encouraging domestic savers to invest, the current spate of initial public offerings (IPOs) amount to "a bad deal for investors and the Chinese public alike". The government retains management control, precluding major corporate shake-ups, while official meddling with the listings process - which interferes with capital allocation, the market's most basic function - has deterred many private firms from floating. The modernisation of investment banking, meanwhile, has been hampered by a tradition of underpricing new issues, which discourages investment banks from researching IPOs: if all stocks rise after floating, why bother?

But it isn't just the IPOs you need to be wary of. Loose monetary policy and government hype have propelled shares on the loosely regulated Shanghai market to a p/e of 30 - double the valuation of the higher-quality Hong Kong-listed mainland firms, which are largely off-limits to mainland investors. Yet Hong Kong-listed mainland firms have also "lost some of their shine" of late, following the news of accounting shenanigans at China Life before its $3.5bn December flotation, says Benjamin Morgan in Channel NewsAsia. Falsified documents at the supposedly transparent private bank China Minsheng Banking Corp, due to list soon, are another reminder of corporate governance shortcomings. But despite this, and the still record valuations, investors still seem keen on the $20bn of IPOs now in the pipeline.

They should tread carefully, says Steve Sjuggerud on www.Dailyreckoning.com. Enthusiasm for China is out of hand. Four Nasdaq-listed Chinese internet firms are trading at almost 20 times sales. Even the "wildly overvalued Microsoft" is on a price/sales ratio of 8. "Does that make any sense?" People are simply "throwing their money at China" with no idea what they're buying. Investors beware.