China’s state-owned telcos have an unerring ability to foreshadow broader capital market trends and China Telecom was at it again last week, when it went public in Shanghai.
The Rmb54 billion ($8.3 billion) deal is China’s largest domestic IPO of the year. It’s also the fifth largest to take place in the A-share market, behind the series of privatisation deals by state heavyweights such as Agricultural Bank of China and PetroChina between 2007 and 2010.
However, it’s not just a considerable length of time that separates China Telecom’s IPO from its predecessors. There is a different underlying ethos: its A-share listing could herald a new period when the domestic bourse becomes a place where investors can find stocks offering stable returns rather than only speculative growth punts (or so China’s regulators hope).
A combination of Sino-US geopolitics and broader and deeper domestic stock markets means Shanghai is now an increasingly attractive venue for Chinese firms to list, including giant state-owned enterprises (SOEs).
However, for historical reasons A-share investors have generally been more cautious when it comes to investing in the IPOs of leading SOEs. They learned that lesson the hard way. The share price of PetroChina, for one, surged to Rmb46 from an offer price of Rmb16 during its Shanghai debut in 2007. But most punters who bought on that first day never got the chance to profitably exit. The oil producer’s share price plunged below the IPO price and was still there this week (it traded at less than Rmb5).
Many are worried that the same could happen with China Telecom. Indeed, the carrier’s shares ended their A-share debut on August 20 at Rmb6.11, or 35% higher than the offer price (Rmb4.53). But it has all been downhill since. As WiC went to press each share was worth Rmb4.6.
Financial regulators have long been calling on investors to focus on companies’ long-term growth potential. That’s why there’s been a lot of chatter about China Telecom’s high dividend payout ratio and its stabilisation pledge – i.e. a commitment to buy its own A-shares if the valuation dips below one times book value for more than 20 days.
Both China Telecom and China Mobile have been raising their payout ratios in recent years. China Telecom has lifted its from 31% in 2013 to 44.4% in 2020. It has committed to pay 60% of net profits back to investors this year and 70% within three years. At the company’s IPO price, this equated to a 3.4% dividend yield. China Mobile is in an even stronger position given its enormous cash pile. At the end of the first half, it was sitting on HK$637.2 billion ($82.3 billion) in cash and short-term investments (more than half of its current HK$1 trillion Hong Kong market capitalisation). China Telecom recorded a much lower cash position of HK$44.8 billion by comparison.
China Mobile is also looking to list in Shanghai and both companies IPO prospectuses share the same language on dividends and stabilisation policy. In particular, the government wants to move away from the oft-repeated pattern seen in hot China IPOs where a surplus of investable cash encourages locals to drive stocks up to frenzied and unsustainable valuations before they come crashing back down again, often hurting the less savvy mom-and-pop investors.
Instead, the government wants to encourage longer-term investment horizons and more predictable returns so that the country’s growing middle class has a safer place to park its savings. It hopes that more such companies will follow China Telecom and China Mobile’s lead.
If they do so, the average dividend yield of the Shanghai Composite Index might rise above government bond yields. The former currently stands at 1.95%, almost 100 basis points (bp) lower than 10-year government bonds. By contrast, the S&P 500 offers a 27bp pick up on US Treasuries
Meanwhile the A-share IPO has lifted China Telecom’s valuation. At 17.6 times forward earnings, it was pitched above other global telcos in the mid-to low-teens. The IPO price also represented an 87% premium to its Hong Kong H-shares. Will this premium narrow? China Mobile will provide the next valuation test when it brings an even larger Rmb56 billion IPO in the coming months.
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