Why China's IPOs are hotter than ever

BEIJING • Chinese stocks may be tumbling at the fastest pace in seven years, but one part of the US$5.2 trillion (S$7.4 trillion) market is hotter than ever: initial public offerings (IPOs).

The six Chinese companies that took bids from IPO investors over the past two weeks attracted orders worth 7.1 trillion yuan (S$1.5 trillion), more than the value of Australia's entire equity market.

The offerings - the first under new rules that allow investors to bid without making upfront deposits - were oversubscribed by more than 1,800 times on average.

Now that IPO orders no longer tie up cash, the deals have turned into the equivalent of lottery tickets that only require buyers to pay if they hit the jackpot. Gains are seen as virtually assured because regulators have capped IPO price-to-earnings (PE) ratios at levels less than half the median valuation on mainland exchanges, a ceiling that led to average one-month returns of 383 per cent last year.

While the odds of securing an allocation are minuscule, the prospect of outsized profits is proving hard to pass up as investors try to recover from last month's 23 per cent plunge in the Shanghai Composite Index.

"Returns are guaranteed," said Mr Wang Zheng, the Shanghai-based chief investment officer at Jingxi Investment Management. "That's why everyone is so willing to participate in bidding and demand for new shares is so high."

The valuation cap - at 23 times earnings - is one of many market distortions introduced by Chinese authorities in their effort to protect individual investors in one of the world's most volatile equity markets. The government has also ordered state-linked funds to buy stocks, clamped down on futures trading and restricted stake sales by major shareholders.

Mr Wang said: "The 23 times PE ratio is a line no one dares to touch now. The regulator will conduct 'window guidance' should anyone overstep it."

China's securities regulator said in December that it would no longer require investors to pay upfront for IPOs, a rule that had been wreaking havoc on liquidity conditions in the nation's financial system.

Almost every time a new batch of companies took orders over the past year, money-market rates climbed and the Shanghai Composite slumped as investors hoarded cash for their bids.

"The good thing about the new IPO system is that it won't cause wild swings in liquidity," said Ms Wei Wei, an analyst at Huaxi Securities in Shanghai.

For the six deals priced under the new system, odds of getting an allocation were 0.05 per cent, according to data compiled by Bloomberg from exchange filings. That compares with about 0.5 per cent under the old rules.

The boom in IPO orders comes before an anticipated shift to a more market-based registration system later this year.

The new regime would leave the questions of IPO supply and timing to companies and the market, rather than the China Securities Regulatory Commission, and give firms more power to determine pricing.

The perception that IPOs are riskless has encouraged some investors to use borrowed money to amplify their wagers, exposing them to deeper losses once prices stop climbing.

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on February 03, 2016, with the headline 'Why China's IPOs are hotter than ever'. Print Edition | Subscribe