Money Matters
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Put Chinese punters in Hong Kong’s penny stock market, and you get...

PUBLISHED : Friday, 15 April, 2016, 11:06pm
UPDATED : Saturday, 16 April, 2016, 11:33am

Why would a civil engineering company that earned only a few million dollars last year rocket 14 times above its offering price on its first trading day?

The chairman’s daughter may be much loved on TV, winning Luen Wong headlines on the entertainment page. But the market, we thought, is a different beast. And, getting a market valuation of HK$11 billion – dwarfing that of the city’s largest TV station – would need a lot more than a telegenic starlet.

Apparently not. And Luen Wong is not the only one. Most new issuers on the second board have exhibited similarly stellar performances in recent months.

Shell games hide an ugly side to otherwise legitimate listings

Old-school market men still talk about “price and liquidity management” by a major shareholder, an euphemism for you know what. Yet, thanks to mainlanders’ hunger for listed shells and investment products, even this trick has become redundant. The same thing is now done with far less hassle and risk, say insiders.

Imagine you are a major shareholder who wants to boost the volume and price of the stock. The greater the control you have over the public flow, the better. Therefore, the last thing you want is to have hundreds of strangers holding the shares.

The Growth Enterprise Market (GEM) rule is a blessing for you. This is because it allows sale of shares by placement only. But the regulation requires the public flow to be in the hands of no less than 100 investors.

In the old days, this would be a tough task. Who would want to risk his money on a shabby company? So you would have to come up with the money to subscribe for the shares. That meant you didn’t get to raise any cash.

Second, you would need 100 identity cards to subscribe to the shares. If you didn’t have enough uncles, aunties and cousins to help, you would have to seek “external help”, for a fee, of course.

Even then the risks were high. In the case of placement-only deals, regulators would naturally screen each and every name on the subscriber list. Why is this auntie, who has never traded stock, on the professional investors’ list?

It’s a different ball game now.

Brokerage firms now pay you according to the price of a listed shell in return for a solo role in underwriting. It is therefore no surprise that most new issuers are selling a 25 per cent control for HK$70 million to HK$90 million, given the shell is trading at HK$300 million.

China’s yuan carry trade marries Hong Kong’s derivate, and a beast is born

Isn’t it great that you actually get to raise some money? You wonder who would come up with the money and the identity cards. The answer is, many. The attractions are obvious.

While the downside is capped by the shell price, the upside is boosted by a highly limited supply of shares. First, the controlling shareholder is not allowed to sell down in the six months to come. Second, the underwriter normally ensures no more than 25 investors get 95 per cent of the shares. The genuine free flow would only be five per cent for the next six months. That makes manipulation easy.

A few times of price increases in the first few days of trading would be sufficient to squeeze out most of the public investors and dry up the public flow. It doesn’t require a lot of money. As long as the rise is sharp and persistent enough, the herds will follow and finish off the work.

Of course, this will work only if it’s limited to a small circle. If one studies the record of the clearing house, one finds the shares always ending in the accounts of the same two dozens brokerage firms.

“A few years ago, you would be doing me a big favour by getting into the circle. Now it is the other way round,” said an insider.

Once the public flow is dried up, the sky is the limit. Normally, the cost is recouped in the first few days of trading itself.

Hong Kong’s red-hot corporate shell game is cause for concern

More than HK$100 million worth of shares have changed hands ever since the listing of Luen Wong on Monday. This compares to the HK$60 million paid by investors to subscribe to its shares via placement.

One question remains, though. How are the lucky few going to profit from this?

The buy low, sell high theory is not a straightforward answer here because trading of GEM stocks will always thin out after a month. Cashing out can be done in another way – margin finance.

Say, one puts HK$10 million into a stock to boost its price to HK$100 million; pledges the stocks at 80 per cent discount to get HK$20 million and buy an investment product with 5 per cent guaranteed return.

But who would take a GEM stock trading at 100 times price-earnings (PE) ratio as collateral? The new rich up north.

When you have been trading A shares at 500 times PE every day, you treat the stocks in Hong Kong’s GEM market not as rubbish, but blue chips.

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