Across The Border

Zombie stocks’ party may be coming to an end as China set to tighten delisting rules

Stricter rules seen as providing support for China to launch long-awaited registration-based initial public offering reform

PUBLISHED : Monday, 10 July, 2017, 6:49pm
UPDATED : Monday, 10 July, 2017, 11:09pm

A Shenzhen-listed hotel operator just became the first delisted stock in Chinese markets in 2017, and more delistings are in sight.

As the authorities hint that more problematic companies will be taken off the market this year, the party might be coming to an end for the many “zombie” stocks that are often on the verge of delisting but keep rising from the dead through “decoration” of their financial statements, analysts said.

Shenzhen Century Plaza Hotel, which went public in 1994 and had been suspended from trading since 2015 due to persistent losses, was removed from the Shenzhen Stock Exchange at the end of last week. It was the first stock delisted from the Chinese market this year.

Next up is Dandong Xintai Electric. The Shenzhen exchange said last month that it will end Dandong Xintai’s listing status on the start-up board and remove the stock 30 trading sessions after July 17.

The exchange has also suspended the listing of Ingenious Ene-Carbon New Materials amid three consecutive years of losses, and warned the company would be delisted if it did not turn a profit within six months.

So far, the number of suspended companies has reached six this year, the highest since 2011.

“The regulators have obviously sped up forced removals of problematic companies from the A-share market,” said Cheng Yimin, the chief analyst for China Post Securities.

“We expect the delisting rules to tighten further this year.”

It is unusual for public companies to delist their shares – voluntarily or by force – from the Chinese stock market, which has a relatively young history compared with Western counterparts.

The regulators have obviously sped up forced removals of problematic companies from the A-share market
Cheng Yimin, chief analyst, China Post Securities

China formally laid out its delisting rules in 2001. But according to data from Wind Financial, less than 100 companies have been removed from the market since then, with the annual delisting rate averaging 0.35 per cent. Excluding mergers or acquisitions by third-party companies, the total number of delisted stocks is less than 60.

“China’s delisting rate is extremely low, compared with the New York Stock Exchange’s 6 per cent and the Nasdaq’s 8 per cent,” said Guo Jianan, an analyst for Lianxun Securities.

The main reason is a loophole in the system design, which allows some companies to avoid delisting by various means, including “decorating” their financial statements.

The motivation to do so is high. Shell companies are valuable resources in the A-share market due to the lengthy and difficult process of initial public offerings.

“Even problematic companies are reluctant to give up their listing status, as their ‘shells’ are valuable,” Guo said.

Investors also like speculating on such “junk stocks”, as they know these companies will not be expelled and have high expectations of potential debt restructuring.

Another reason may be that a listed state-owned enterprise usually involves many “interest groups”, including employees, creditors and sometimes even local governments, said analysts from China Galaxy Securities in a recent research report.

“Some local governments will strive to protect the listing status of certain companies at all costs,” the report said.

Cheng said that the existence of these “zombie” stocks “have twisted the valuations of A shares and siphoned away capital from quality companies”.

It has also “led to wild speculation” in a market dominated by retail investors.

However, regulators have launched a comprehensive crackdown on speculative stock investments this year and suggested they would strengthen supervision of companies that did not comply with listing requirements.

“More zombie stocks could be forced out of the market this year,” said Xun Yugen, an analyst for Haitong Securities.

He said stricter delisting rules will provide support for the regulators’ plan to launch a United States-style registration-based initial public offering reform, which would reduce the government’s role and let the market decide which companies listed.

The current approval-based IPO system relies on strict financial requirements and stringent reviews by the regulators.

The new registration-based system would impose a lower threshold and simplifies the listing process.

“Before the regulators launch the IPO reform, they need to clear up the market first,” Xun said, citing Taiwan’s moves in 1988, which launched a tougher delisting mechanism before introducing its registration-based IPO system.