Institutional investors should be wary of piling into new Chinese technology company listings as the hullabaloo builds up ahead of the launch next month of Shanghai’s new tech board
Because while Shanghai's Sci-Tech Innovation Board promises to be "China's Nasdaq", markets in China – including Hong Kong – are very different from those in the US.
For one thing, equity markets in Greater China are distinctly more retail-heavy, noted Irene Chu, Hong Kong head of new economy and life sciences at consultancy KPMG.
Whereas the ratio of share-trading activity between between retail and instutitonal investors in the US might be 20:80, in China it's more like 80:20.
That difference is important for the success of new economy IPOs because there’s a cognitive lag between the retail investors that dominate the Hong Kong and Chinese markets and the institutional investors that dominate the US market, Chu told AsianInvestor.
Basically, it takes retail investors longer to understand the business models of new tech firms and the value they can generate.
For example, the data such companies accumulate can become very valuable, but they can also take a long time to become profitable, Chu said. Retail investors aren’t necessarily used to this.
Others made a similar point.
Retail investors in Greater China often don't fully understand how long i will take for tech companies to make a profit, said Michael Kerley, director of pan-Asian equities at Janus Henderson Investors.
So an IPO's success can often rest on how well known a company or its sponsors and managers are.
“A name that is well known in China will probably get general retail support,” London-based Kerley said. “But if it’s in an area that no one’s heard of and is hard to understand, then it won’t be very popular.”
Ultimately, tech and biotech listings are more likely to struggle to perform in Asia than in the US because there are more sophisticated specialist public equity investors in the US, the Asia head of investments at one North American pension fund told AsianInvestor.
An upshot of this is that there is perhaps less of an incentive to come to market quickly, so that when 'new economy' companies do come to market, they've gone through several private funding rounds and are more developed and expensive companies.
Traditionally, corporates go public to raise capital to fund their growth, provide liquidity to their early investors and raise their profile, said Chris Emanuel, co-head of the technology investment group at Singapore sovereign wealth fund GIC. Today, there is enough private capital for companies to achieve the first two objectives without going public, he told AsianInvestor last month.
As a result, “companies are staying private roughly two times longer than in past cycles and we have seen late-stage valuations increase materially,” he said.
Hence by the time these companies get to IPO, it’s kind of a reality check, and retail investors are perhaps not as prepared to pay such a high valuation,” KPMG's Chu said.
Of course, such high valuations of companies are not unique to China. Several high-profile tech IPOs have underperformed recently. Not just Ping Au Healthcare and Technology, Xiaomi and BeiGene in Hong Kong, but also US duo Uber and Lyft.
Companies globally have generally been achieving higher prices in the later-stage private funding rounds than post IPO.
But for some market observers, it's arguably a bigger issue in China than elsewhere.
Given the strong demand, large market size and better exit multiples, premiums for Greater China plays are at least three to four times higher than elsewhere in Asia, estimates Kenny Ho, managing partner of Carret Private, a multi-family office based in Hong Kong.
A key upshot of this is that more asset owners are likely go into earlier private funding rounds, where valuations are less pricey, the US pension executive noted.
Citing Xiaomi as an example, he said: “I believe both pre-IPO and IPO round investors [in the company] are still under water based on the current share price.” Shares in the Chinese electronics giant stood at HK$9.49 at the close of trading on July 11, only a little over half their listing price of HK$17 in June 2018.
For the long-term investor hoping to extract the full value from a potential blockbuster business, there's another factor too: how commited company’s management are to their business.
This is particularly important in China, where “it’s become a business to set up a startup with the aim of selling it as soon as possible to Alibaba, Tencent or an equivalent”, said Kerley of Janus Henderson.