China’s curbs on overseas deals deflate ChiNext bubble
China’s small-cap stocks may drop further as efforts by policymakers to curb the overseas buying spree by domestic corporates are exposing the weakness of their financials, analysts said.
Shenzhen’s tech-focused ChiNext index is stabilising near a 30-month low after nearly 500 stocks fell by their daily limit of 10 per cent on the Shanghai and Shenzhen stock exchanges early last week in what analysts dubbed as “Black Monday”. The price to earnings ratio for the ChiNext index has dropped to 47 times from a peak of 145 times in 2015, according to data on the Shenzhen exchange’s website.
The slide in the ChiNext comes after the central government late last year tightened its grip on investments abroad as part of a crackdown on riskier forms of fund raising. On Monday, the official Xinhua news agency said following a meeting by the Communist Party’s top decision-making body the Politburo, chaired by President Xi Jinping, that China will strengthen coordination of financial regulation, stabilise the property market and prevent systemic financial risks.
China’s leading corporations including Dalian Wanda Group, Anbang Insurance, HNA and Fosun International – which had in recent years undertaken a spending spree overseas in line with the government’s “Going Out” policy and internationalisation initiatives – have now come under increasing regulatory scrutiny.
But the crackdown is hurting small firms that have done overseas acquisitions even more because they are unable to meet growth targets promised when the deals were made, resulting in goodwill impairments in company financials and triggering worries over their earnings outlook, analysts said.
In accounting, goodwill impairment arises when there is a deterioration in the capability of acquired assets to generate cash flows.
In recent weeks a number of listed companies on the ChiNext start-up board have issued warnings of significant losses in the first half, including the troubled Leshi Internet Information & Technology.
“Overseas acquisitions are a problem when they are merely used to support fake financial statements,” said Tan Han, analyst at Guotai Junan Securities. “Weak companies showing goodwill impairment after they made overseas acquisitions are gradually deflating a market bubble.”
The ChiNext board and the new third board, the National Equities Exchange and Quotation, were meant to be China’s answer to the US Nasdaq exchange for technology start-ups.
Investors in recent years have been chasing a wave of Chinese start-ups listed on ChiNext and the new third board which promised “high growth prospects” with their overseas investments.
But this allowed small firms with declining profits to use overseas investments to dress up their balance sheets and avoid being delisted, while supporting inflated stock prices.
The value of overseas acquisitions made by acquirers listed on ChiNext – including the net debt of the target company – rose 146 per cent year on year to US$2.2 billion in the first half of 2017, according to Thomson Reuters data.
“When financial conditions were strong, China may have allowed overseas acquisitions such as the purchase of iconic buildings or iconic businesses as part of its soft power [push],” said Alicia Garcia Herroro, Asia Pacific chief economist at Natixis. “But given the capital outflow concerns now, China may not want to spend money on such acquisitions that don’t provide technologically advantages and when hard currency is scarce,” she said
Analysts also say that purchasing assets unrelated to their own core business can waste a companies resources. “China is now rationalising its purchases abroad after this learning process,” Herroro said.
However, the government’s crackdown has made it more difficult for listed companies, especially those in poor financial health, to raise funds for overseas acquisitions while stronger, larger corporations will be less affected because they are able to grow organically, said Qiu Zhicheng, executive director and strategist at ICBC International.
In February, the China Securities Regulatory Commission (CSRC) tightened rules for the sale of private share placements by mandating that such sales should not be made within 18 months of a previous fundraising round by the firm. In May, the CSRC also required substantial shareholders to space out the disposal of their stakes in publicly traded companies by barring them from selling their holdings through so-called block trades.
Previously, major investors could purchase shares in a domestic company through a private placement at a 20-30 per cent discount price, then when the company made a overseas acquisition that caused the stock price to rise, the investor would sell the shares and profit from the arbitrage. CSRC’s revised rules are reining in such financing activities.
Currently, IT start-ups and small firms remain in a stock bubble but valuations for stocks in sectors such as financials and cyclicals have returned to more reasonable levels, said Guotai Junan’s Tan. Meanwhile, Qiu predicts ChiNext’s price to earnings ratio to slip further to about 30 times.
With additional reporting by Yu Yifan