Tencent’s very good book

Pony Ma launches IPO of the year

Little did Thomas Hardy know he’d invented the nomenclature for a new genre when he left Henry Knight dangling from a cliff edge at that end of a chapter in A Pair of Blue Eyes. The cliffhanger, as it was subsequently known, was a staple of nineteenth century fiction, which was often serialised in monthly magazines. One of the most famous examples came in 1841 when Charles Dickens fans – desperate to know Little Nell’s fate in The Old Curiosity Shop – stormed the New York docks as the final instalment came steaming into port.

A Chinese company has used a similar technique to great effect in the digital age. China Literature, which has just listed on the Hong Kong Stock Exchange, allows customers to read the first chapter of online books for free before deciding whether to pay for the rest.

As marketing devices go it is simple but effective and it is one of the reasons why China Literature’s IPO has been one of the biggest blockbusters in recent history. Although perhaps of even greater importance is the star power of its backer: Tencent. The internet giant’s stock has richly rewarded investors (up from HK$3.70 to HK$1,928, if you account for stock splits along the way).

In 2004, Tencent received a fairly subdued response from investors when it came to market. In 2017 the Pony Ma’s firm clearly decided not to make the same mistake with China Literature. Appetite for the flotation has been nothing short of frenzied among Hong Kong retail investors. Some HK$520 billion ($66.7 billion), or a third of the territory’s M1 money supply was said to be tied up in it, causing interbank borrowing rates to rise. If you put that into an American context it would mean the equivalent of $3.55 trillion of investor cash chasing a single deal.

Most investors were disappointed, with 8,000 retail punters allocated one board lot each. This also helps to explain why the stock attracted equally frenzied trading during its first day on Thursday, rising more than 86% from HK$55 to HK$104, and valuing the company at $11.9 billion.

The South China Morning Post describes China Literature’s IPO as a supernova – a term for the explosion of a giant star – which may yet prove apt. The company’s valuation is certainly out of this world, considering China Literature only turned profitable in the second half of last year, registering net income of just $4.6 million. This means it now has a trailing valuation of 1,741 times 2016 earnings.

Syndicate analysts forecast net profits will rise to $150 million in 2018, although they have attached health warnings about a lack of comparables. But on this basis, China Literature has a more “reasonable” valuation of 79 times its forecast 2018 earnings.

China Galaxy Securities believes the e-publisher could continue travelling at warp speed. The broker bases its assessment on the performance of the company’s one Shanghai-listed comparable, iReader. It closed on Wednesday at Rmb64.72, or 133 times forecast 2018 earnings. After accounting for the average discount between shares traded on the two exchanges, China Literature would still need to trade at about 96 times forward earnings to be at the same level. This implies further upside of at least 20.46% in the share price.

iReader’s share price performance has also been nothing short of inter-galactic too since it listed in September, having risen almost tenfold. But in many ways, iReader should trade at a discount to China Literature since it ranked second in the e-reading market at the end of 2016 with a share of 14.9%, compared to China Literature’s 43.2%.

Investors are betting both companies are still at the beginning of a very steep growth curve as they start to monetise their content. For instance, China Literature has said it wants to branch out into other forms of media such as films and TV.

They will both be hoping to avoid a Thomas Hardy style denouement as the author was never known for his happy endings. The unfortunate Henry Knight was saved from the cliff edge after his beloved, Elfride, tied her petticoats together to create a rope. However, the two lovers soon parted after he learned another suitor once courted her. Regretting his decision, he later takes a train to Cornwall to win her back, only to discover she is travelling on the very same train – but in a coffin.

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