What’s next for ChiNext? Black sheep is comeback kid

What’s next for ChiNext? Black sheep is comeback kid

By Ye Zhen | August 12, 2013, Monday |  PRINT EDITION

CHINEXT, the once troubled board for start-up companies in the southern city of Shenzhen, has been logging strong performance this year, underscoring expectations that the commitment by China’s new leadership to rebalance the economy will benefit small and private businesses. The ChiNext Index, which tracks a Nasdaq-style exchange for growth enterprises, has leapt a stunning 63 percent so far this year, while the CSI 300 index, the benchmark for blue chips in Shanghai and Shenzhen, has slumped 10 percent. ChiNext closed at 1,172.52 points on Friday.Premier Li Keqiang has pledged to restructure the economy by reducing government intervention, advancing market-oriented reforms, easing dependence on exports and promoting consumer spending. Investors see that as a green light for innovative small companies eager to unleash pent-up creativity.

“Emerging industries are seen as the new engines of economic growth in China, while the investment-driven mode of expansion is challenged by limited resources and rising costs,” said Yuan Wei, a fund manager with Dacheng Fund Management Co.

Launched with fanfare in October 2009, with a first round of 28 listings, ChiNext is designed to provide a fund-raising channel for innovation-driven companies and other high-growth enterprises that usually have difficulties securing bank loans.

However, the ChiNext bourse in its first few years was a far cry from what promoters promised. It was accused of operating like a casino and was haunted by inflated first-day prices, rampant speculation, accounting scandals and underperforming earnings. The index hit a record peak in December 2010 and then headed south, dropping to a record low of 585 last December.

With current capitalization of about 1.3 trillion yuan (US$213 billion), the board now is home to 355 firms.

While large-cap financial stocks have taken a hit from the interbank liquidity crunch in June and cyclical shares have suffered from the waning momentum of economic expansion, small caps on ChiNext have been high on the buy list of many institutional investors.

Fund managers have been increasing their holdings of ChiNext shares for five straight quarters, according to Wind Information Co.

A survey of more than 100 institutional investors by Guotai Junan Securities found about half of respondents had holdings of growth shares above their historical average levels and more than 60 percent were bullish on the outlook for growth stocks in the second half of the year.

“ChiNext is dominated by shares of IT, media, pharmaceutical and environmental protection sectors, which are less exposed to the current economic downturn,” said China International Capital Corp. “These industries are likely to benefit from technological progress and policy stimulus.”

Growth enterprises

China has been tilting policy support toward growth enterprises since the new leadership took office in March, with a slew of targeted pro-growth polices for emerging industries, an expansion of value-added tax reform, tax waivers for small businesses and promises of a better financial environment for start-ups.

The TMT50P Index, which tracks the performance of 50 Shenzhen-listed technology, media, and telecommunications companies, has soared 73 percent since December as China has unveiled plans to encourage wider use of IT products and measures to reduce censorship for the media and publishing sector.

It is a bit reminiscent of the dot-com mania in the late 20th century, when the tech-heavy Nasdaq index shot up more than sevenfold to a record 5,048.62.

The boom was followed by a burst, with the Nasdaq crashing to 2,000 within months, leaving many businesses belly-up and the dot-com industry in shambles.

That outcome is not far from the minds of market watchers as the ChiNext Index approaches its record high of 1239.60.

“With high-flying stock prices, ChiNext shares are facing increasing risk due to over-valuation and over-optimism,” the CICC warned.

ChiNext shares are currently trading at an average 48 times earnings, compared with a price-to-earnings ratio of 10 on the CSI 300, according to China Securities Index Co.

Disappointing investors

Half-year earnings scheduled to be released later this month may disappoint investors expecting more than 30 percent annual growth this year.

According to forecasts from ChiNext companies, 44 percent point to losses in the first half and 11 percent put the losses at more than 50 percent.

The overall net profit of ChiNext companies for the first half is estimated to rise 3 percent from a year earlier, a slight recovery from the 2 percent decline in the first quarter, according to calculations from Industrial Securities.

“The ChiNext bubble is being gradually inflated as some small-cap shares get too expensive in the face of poor business performance,” said Hu Xinhui, a researcher with Huatai Securities.

Moreover, a glut of shares is also expected to weigh on market as ChiNext enters the peak season for release of locked-up shares and the restart of initial public offerings after a nine-month suspension.

An estimated 47.5 billion yuan of non-tradable shares will be released from lock-up periods on the ChiNext this month, followed by 39.1 billion yuan of shares in September — the biggest numbers since the birth of the ChiNext exchange, according to Southwest Securities.

At the same time, the resumption of new share offerings hangs like the sword of Damocles over ChiNext. To date, 43 of 83 IPO candidates that have passed the regulatory IPO review are set to debut on ChiNext.

Despite the drawbacks, market watchers still see value in ChiNext.

“It is an inevitable trend that emerging sectors will increasingly gain focus against the backdrop of economic transformation,” said Orient Securities. “Companies with solid fundamentals and robust earning growth will stand out because a strong business performance is always the fundamental support for a company’s share price.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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