Banking & Finance

Have doubts, will discount

Grey market deals hint that ChiNext is overvalued

What goes up must come down

When trading started on China’s new growth enterprise board, the ChiNext, at the end of October, some investors couldn’t cash out soon enough.

Take retail investor Joyce Chen. She had sold off all of her shares in Qingdao TGOOD Electric before the close of the very first session. But even by lunchtime they were up to Rmb40 ($5.85) apiece, much more than the Rmb23.80 that she paid for them during the IPO. She ended up pocketing Rmb8,000 for her day’s work, more than double the average monthly salary in Shanghai. “I never expected the price to surge that high,” Chen told the Shanghai Daily.

Some of the larger shareholders in ChiNext-listed companies will envy Ms Chen’s nimble-footedness. The problem for the larger investors is that they are subject to lock-up clauses that restrict them from selling their shares until a year after the IPO.

As a result, some shareholders are trying to offload their stock on the grey market before common sense pulls prices back to Earth.

One investor told China Business magazine that he was offered shares in ChiNext-listed film studio, Huayi Brothers, at half the market price. He was approached directly by the shareholder and by various intermediaries peddling shares on the board at a similarly deep discount.

A 50% discount is normal in this kind of off-market trade. For many of the 28 companies listed on the ChiNext that has taken stock prices back close to issue prices when the board was launched.

The transaction has to be slightly nuanced to get round the lock-up restriction: once the buyer and the seller have agreed on a discounted price, they then sign an equity pledge agreement to transfer the stock at the end of the lock-up period.

When the shares become liquid, they are then transferred to the buyer. The seller receives payment when the deal is brokered.

This is a tried and tested technique on China’s main board in Shanghai too, where a 30% reduction to the market price is more commonplace. But discounts on the ChiNext are on a completely different scale – they can be as deep as 60% – which corresponds to the level of risk associated with a market where stocks have been fluctuating by 10% in a single session.

“The stock prices have been overvalued and we want cash in advance,” is how China Business sums up the attitude of many larger shareholders in ChiNext companies.

The rationale for sellers is that the issue price still represents a reasonable valuation and that it is only a matter of time before market prices revert to more realistic levels. So why not sell at the issue price now, thus freeing up capital that can be put to better use, rather than wait a year?

It’s a strategy that implies a rather negative outlook on the ChiNext (and maybe vindicates those who said its opening day exuberance was all just a speculative bubble).

Some funds seem to be pessimistic longer-term too: even deep discounts on offer have not been enough to attract buyers on some stocks.

But for a contrarian investor that picks the right company, there could be hefty profits.

If a buyer purchases shares at a 50% discount and the price holds up better than expected, he is going to be in the money.

And for the companies that live up to their growth potential (ChiNext is supposed to be about growth firms, after all) there could be further price upside.

So, certainly not a trade recommended for the faint-hearted. But get it right, and some of the returns could be fantastic.


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