Tuesday, July 03, 2007
Thoughts on H-share & Red Chips Index
This is a continuation of yesterday's post.
One important distinction to make about red chips: I only mean those controlled by the government, e.g. China Mobile, not those owned by private country men, e.g. Citic Pacific. I don't mean the latter has less investment value (in fact I own Citic Pacific) but it's just outside the scope of today's discussions.
And I'll only use the term 'H-share' throughout even I mean red chips as well, just to save typing time. Make no mistake this post is definitely not about investing in 'A' shares.
Right now I see there are at least 4 favorable factors at work driving the H-shares.
(1) China growth story - no need to explain. The China story is more compelling than many others (notably Russia) because it's not resources dependent; on the contrary it's China's ability to grow despite the lack of it that'll make its growth sustainable. The theme will stay for at least another decade amid temporary setback from time to time. Keep in mind the old saying: when the tide comes all ships shall float. I'll add even if you've picked a sucker you're likely to be rescued some point in time.
(2) Industry consolidation - it's clear the government is leaning toward larger national enterprises in policy making and squeezing out smaller private competitors. This will save on the energy bill, environmental cost, increase competitiveness, etc, plus the government will benefit since they own those companies. By forcing the management to pay dividends there'll be funds to implement various social policies.
(3) QDII - though the actual fund flow will come in later and in stages, stock prices always move before facts. This is almost the exact duplicate of the 'freedom tourists' in 2003, save it's 'freedom money' buying cheaper stocks. Remember the last time the share price of many retailers never retreated until 2005! Don't doubt the immediate impact this time.
Looking from another angle, if the Chinese have that much money to create the expensive A-share market, they should have little trouble repeating that in HK whose market turnover is only a fraction.
(4) Asset injection - more national assets are getting listed by injection (or listing) and so far the price set is very reasonable, or you may say unreasonably reasonable. The official explanation is these assets belong to the people and it's only fair the people get to share the prosperity of their country. If there's a crash down the road, the government can also avoid being accused of selling at the top and reaping its own people off, a big no-no in a communist country. The management of these vendor companies are only civic servants so don't expect them to bargain for a good price for the government.
A favorable injection price will ensure favorable response, not only to those receiving the 'gift' but also to their peers, who like a spoiled child, will go to his father and ask for similar treatment. If the injection price is set at a discount to the A-share peers, A-share (of the subject company) will respond and H-share will follow suit (if not immediately, QDII and speculators will ensure it does). If the injection price is set at a discount to the H-share peers, H-share will respond but A-share will go wild, then H-share will go wild too.
The other catalyst to this dynamite is the means of financing and I'm seeing more and more A-shares being issued as consideration. This serves the legitimate purpose of increasing supply which fits in the government's cooling measures. To the company though, it's free capital! Since the management own near zero equity stake they'd care less about dilution than growing faster than its peers, as otherwise their companies would get taken over and they'd lose their helms. How will this affect the H-shares? Of course the effect is highly positive as issuing A-shares, even at a discount, will still be at a price vastly above the H-shares, which of course will jump in response.
The scary part is that these 4 factors are interrelated making this upward trend, in Soros's terminology, self-reinforcing. Discounted injection -> higher share price -> more M&A using shares -> reduced competition -> higher profit -> even higher price. This will likely continue until the rationalization is complete and every industry is dominated by a few big players.
To continue.
One important distinction to make about red chips: I only mean those controlled by the government, e.g. China Mobile, not those owned by private country men, e.g. Citic Pacific. I don't mean the latter has less investment value (in fact I own Citic Pacific) but it's just outside the scope of today's discussions.
And I'll only use the term 'H-share' throughout even I mean red chips as well, just to save typing time. Make no mistake this post is definitely not about investing in 'A' shares.
Right now I see there are at least 4 favorable factors at work driving the H-shares.
(1) China growth story - no need to explain. The China story is more compelling than many others (notably Russia) because it's not resources dependent; on the contrary it's China's ability to grow despite the lack of it that'll make its growth sustainable. The theme will stay for at least another decade amid temporary setback from time to time. Keep in mind the old saying: when the tide comes all ships shall float. I'll add even if you've picked a sucker you're likely to be rescued some point in time.
(2) Industry consolidation - it's clear the government is leaning toward larger national enterprises in policy making and squeezing out smaller private competitors. This will save on the energy bill, environmental cost, increase competitiveness, etc, plus the government will benefit since they own those companies. By forcing the management to pay dividends there'll be funds to implement various social policies.
(3) QDII - though the actual fund flow will come in later and in stages, stock prices always move before facts. This is almost the exact duplicate of the 'freedom tourists' in 2003, save it's 'freedom money' buying cheaper stocks. Remember the last time the share price of many retailers never retreated until 2005! Don't doubt the immediate impact this time.
Looking from another angle, if the Chinese have that much money to create the expensive A-share market, they should have little trouble repeating that in HK whose market turnover is only a fraction.
(4) Asset injection - more national assets are getting listed by injection (or listing) and so far the price set is very reasonable, or you may say unreasonably reasonable. The official explanation is these assets belong to the people and it's only fair the people get to share the prosperity of their country. If there's a crash down the road, the government can also avoid being accused of selling at the top and reaping its own people off, a big no-no in a communist country. The management of these vendor companies are only civic servants so don't expect them to bargain for a good price for the government.
A favorable injection price will ensure favorable response, not only to those receiving the 'gift' but also to their peers, who like a spoiled child, will go to his father and ask for similar treatment. If the injection price is set at a discount to the A-share peers, A-share (of the subject company) will respond and H-share will follow suit (if not immediately, QDII and speculators will ensure it does). If the injection price is set at a discount to the H-share peers, H-share will respond but A-share will go wild, then H-share will go wild too.
The other catalyst to this dynamite is the means of financing and I'm seeing more and more A-shares being issued as consideration. This serves the legitimate purpose of increasing supply which fits in the government's cooling measures. To the company though, it's free capital! Since the management own near zero equity stake they'd care less about dilution than growing faster than its peers, as otherwise their companies would get taken over and they'd lose their helms. How will this affect the H-shares? Of course the effect is highly positive as issuing A-shares, even at a discount, will still be at a price vastly above the H-shares, which of course will jump in response.
The scary part is that these 4 factors are interrelated making this upward trend, in Soros's terminology, self-reinforcing. Discounted injection -> higher share price -> more M&A using shares -> reduced competition -> higher profit -> even higher price. This will likely continue until the rationalization is complete and every industry is dominated by a few big players.
To continue.
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