Talking Point

Tech stocks go crazy

It’s hard not to fear a bubble is inflating in China’s technology sector

Bao Feng w

At the start of this century America’s dotcom boom turned to spectacular bust. Not long after the carnage ravaged investors’ portfolios car bumper stickers started appearing in Silicon Valley imploring: “Please God, Just One More Bubble.”

A decade later, the valuations of some of America’s favourite apps, tech stocks and social media firms are breathtaking once again, even if more of their funding is coming from private investors rather than the public markets. Once more, companies are talking about eyeballs rather than earnings, as they focus on capturing market share and monetising it at an undefined point in the future.

But, if anything, China’s tech bubble has been gaining speed at an even more frenetic and dramatic pace, and with more of the speculative activity taking place on the nation’s stock exchanges.

Regular WiC readers will be familiar with the astounding rally in Shanghai’s A-share market since late last year (see WiC264, as well as WiC277 for how the euphoria has spilled over into Hong Kong).

The recent performance of a number of tech counters has taken the market exuberance to a new level. Exhibit one: Beijing Baofeng Technology (‘Baofeng’ means “storm” in Chinese). The online video provider went public in Shenzhen on March 24 with a market value of just Rmb850 million ($140 million). Since then it has been a near-perfect performer, with its shares trading up to the 10% limit almost every day. By last Wednesday it was worth Rmb30 billion. In 2014 Baofeng made Rmb42 million in net profit, meaning that it has traded as high as 720 times last year’s earnings.

“Can Baofeng sustain the stormy surge,” the Economic Information Daily asked this week. “Or is it the prelude to a perfect storm?”

How crazy is the tech frenzy?

Excessive risk-taking (i.e. punting) on newly-listed firms has been a longstanding feature of the A-share market. When the market also goes on a broader surge, thousands of investors pile in as well. Mix in stocks with a tech-sounding name and investors have ticked all the boxes in the unholy trinity of their stock-selection strategy.

Currently most of the new debutants in China are marketing themselves as tech counters. More than 50 companies, primarily identifiable as internet and technology firms, have tripled their market values so far this year. They have sprinted out of the blocks: by the Securities Times’ reckoning, the debutants have registered an average gain of 30% in their first trading session (prices are allowed to rise by more than 10% on the first day, though the daily curbs that ensue are less onerous for the Shenzhen bourse than in Shanghai).

“If this is due to underpricing the flotations, lots of Chinese bankers should be fired for misjudging the market entirely,” columnist James Mackintosh complained in the Financial Times, adding that trying to rationalise China’s IPO market looks, for the present, to be a pointless task.

Merely announcing a change of business focus, and a new company name, are often enough to transform underperforming firms into tech-savvy prospects too (see WiC279 for our report on the trend).

Shanghai Duolun, for example, was a struggling real estate developer until it rebranded itself as P2P Financial Information Services. Not that it has taken many concrete steps into peer-to-peer lending. All it’s done is bought the domain name www.p2p.com, which it says is worth $100 million. “This is the craziest story yet,” the Washington Post warns. “It’s a dotcom bubble with ­­­­­­­­­­Chinese characteristics.”

How about China’s tech firms abroad?

A mega deal often marks the point at which bull markets run out of gas, as was the case with the merger between AOL and Time Warner in 1999. At the time the rhetoric was stratospheric, and yet the valuation was viewed as bizarrely plausible by the investment community (Time Warner was valued by acquirer AOL at $164 billion, double the media firm’s market capitalisation the week before the M&A deal was announced).

Then came the plunge. AOL Time Warner reported a $99 billion loss in 2002 as it wrote off goodwill from the acquisition, and saw hundreds of billions wiped off its market capitalisation. (AOL was sold last week to Verizon for $4.5 billion.)

How about the evidence of a similarly ominous China-related mega deal? The listing of e-commerce giant Alibaba in New York last year – the world’s biggest ever IPO – clearly hasn’t punctured the Chinese tech bubble. Nevertheless, it could still be a landmark for Chinese tech firms in how they choose to go public. For years New York has been a haven for bosses keen to extract higher values for their companies from the equity markets. But that may change, as Chinese companies realise that American pastures aren’t always the greenest. Buoyed by brisk sales on China’s Singles’ Day (on November 11), Alibaba’s share price surged to record highs in November last year. But it has since dropped nearly 30%, while tech counters at home have seen their values inflate spectacularly over the same period.

Beijing Baofeng provides another yardstick. The Shenzhen-listed firm is carrying a market capitalisation of more than $5 billion, while New York-listed Youku Tudou, the merger of the two largest online video players in China, has been trading at $4.5 billion.

“It is like falling from heaven to hell for Chinese firms listed in the US,” Securities Times has reported. The newspaper notes that as a result of the widening valuation gap, five US-listed China stocks have been taken private by their controlling shareholders and that more are planning on making the same move. The belief is that most will relist in Shanghai or Shenzhen.

This delisting trend started in 2010 when Chinese firms with questionable financial accounts were targeted by short sellers. But now it is companies with decent corporate governance and proven track records (and growing profits) that are leading the way, the newspaper says.

Who might be the next to depart?

Since the beginning of this year, news reports have been speculating that Focus Media is considering an A-share listing at a valuation of about Rmb46 billion.

That would be three times the online advertising firm’s worth when it was taken private in 2013 in the US.

Tencent Finance reported this month that a backdoor listing could happen as early as June.

The A-share market looks tempting for Baidu too. At a conference hosted by the China Securities Regulatory Commission (CSRC) in April, Baidu’s chairman Robin Li talked wistfully about returning to a Chinese stock exchange.

One of the major obstacles to moving back from New York, according to Southern Weekend, is the search giant’s offshore shareholding structure. Commonly known as VIEs (or variable interest entities), these arrangements are employed to bypass domestic regulations on foreign ownership (see WiC268). Disentangling them would be complex and potentially contentious, although there have been discussions among Chinese regulators about lifting their own restrictions on VIEs in order to bring the best of the Chinese tech stocks home. “Several government departments are studying how to use special rules in Shanghai’s free trade zone to lure back overseas-listed firms with a VIE structure,” Southern Weekend reports.

Is the bubble set to burst?

As of Thursday this week, there were 458 companies listed on Shenzhen’s growth enterprise board, ChiNext. This is where many of the newest media, technology and pharma firms have chosen to congregate. Their combined market cap had surged to Rmb5.6 trillion – having ended last year at Rmb2.2 trillion. Their average price-to-earnings ratio now hovers at 114 times.

Even the most bullish strategists believe that a correction must come sooner or later. Earlier this month, Xinhua published four separate commentaries in as many days pleading with the investing public to be more realistic in their expectations.

“The market will eventually return to rational status,” the news agency warned.

Others scoff at any claims that a meltdown is imminent. After all, ChiNext only accounts for 9% of the total Chinese stock market, i.e. much less than Nasdaq’s 36% weighting in US stocks at the peak of the bubble in 1999. And even if there is a sudden consolidation in ChiNext stocks, the shares of the larger, more traditional state firms (mostly listed in Shanghai) may hold up, buoying market sentiment.

The bulls add that China’s tech sector has a compelling story to tell. In part that’s because Beijing seems to view the internet as a policy tool for the restructuring the domestic economy. Internet giants such as Alibaba and Tencent have been encouraged to pilot a host of reforms, from crowdfunding local movies to setting up private sector banks.

Some also take heart from Beijing’s monetary policy. While the Federal Reserve helped to pop the dotcom bubble in 2000 with a flurry of interest rate hikes, the Chinese central bank has been in loosening mode, with three rate cuts in as many months.

Since financial regulators aren’t flagging more warning signals, investors seem unwilling to leave the party. “Everyone knows there is a bubble, but everyone wants to make quick money trading on market momentum,” Guangfa Securities opined in a research report.

Or do some simply not see the danger? “In bubble territory most people tend to ignore all the warning signs, such as unrealistic valuations,” Beijing News suggests.

“When the bubble pops, not many investors will find themselves unscathed.”

And this week, some speculators have already been learning that market momentum can recede as quickly as it advances where hot stocks are concerned.

In this case, the victims were shareholders in Hong Kong-listed Hanergy Thin Film Power Group. The solar tech firm (see WiC270) had enjoyed a six-fold ramp in its stock price over two years, making it more valuable than Sony and Tesla, and seven times bigger than First Solar, the largest US solar manufacturer.

But its success had confounded most onlookers, not least the editorial team at the Financial Times, which has questioned how the new energy firm’s financials justify such a dizzying valuation.

And on Wednesday, the cynics got their moment of justification, when Hanergy’s stock plunged 47%. Almost $19 billion in market value was wiped out in 24 minutes. Ouch… n


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