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https://scmp.com/business/companies/article/3041135/savvy-new-york-alibaba-traders-bagging-profits-through-temporary
Business/ Companies

Savvy New York Alibaba traders bagging profits through a temporary arbitrage opportunity

  • Alibaba’s Hong Kong-traded shares have cost as much as US$7.68 more than its US stock certificates
  • More confidence in the e-commerce giant by investors closer to home explains the gap
Daniel Zhang Yong, CEO of Alibaba Group, and others celebrate the company's stock trading debut at the headquarters of the Hong Kong Exchanges and Clearing in Hong Kong on November 26, 2019. It joins the Hang Seng Composite Index Monday, and is expected to be available on the Stock Connect at some point next year. Photo: Sam Tsang

It’s an opportunity that will not last, but savvy traders holding US-listed Alibaba stock certificates have been bagging profits by capitalising on shares costing more in Hong Kong.

The manoeuvre is known as arbitraging, in which a trader makes a profit on securities selling on separate exchanges at different prices.

Over the nine days that China’s e-commerce giant has been trading in a secondary listing in Hong Kong, excitement pushed the share price up – beyond what it was in the US. At one point, Alibaba’s shares were as much as US$7.68 more expensive per share in Hong Kong than in New York, where it originally listed five years ago.

Traders were able to exchange their US-listed securities through what are known as American depository receipts (ADRs) for the higher priced Hong Kong shares. Then they were able to sell them and pocket the difference.

Traders in Hong Kong drove the price up in part because they expect Alibaba will become even more valuable once it is eventually added to the trading link between the city and mainland China.

Traders on the mainland – where Alibaba’s electronic payment system Alipay and its online shopping malls are wildly popular – are expected to pile into the home-grown superstar once they can buy it for the first time on the Stock Connect.

Alibaba owns the South China Morning Post.

The premium Alibaba’s Hong Kong-traded shares command “is justified because investors in Hong Kong have higher appetite for China and better understanding of China risks than in the US,” said Karine Hirn, a Hong Kong-based partner at East Capital, which has US$5.4 billion in assets under management. “Also Alibaba will be part of the Stock Connect in about six months.”

Investors in Hong Kong and mainland China are familiar with such price differences.

It is not unusual for Chinese companies to be listed in both Hong Kong and mainland China. The stocks have an average discrepancy of almost 30 per cent. Two camps of traders can have very different mindsets on the same investment.

While the price gaps of the biggest dual-listed companies, such as Ping An Insurance Group and China Merchants Bank, are currently no more than 10 per cent, the most extreme discrepancies are among some small-caps and exceed 300 per cent.

Goldman Sachs is among investment houses expecting big gains for Alibaba in the coming year. It initiated covered of the stock with a “buy” rating and a 12-month price target of HK$252. If it is right, that would be more than a 28 per cent gain.

Part of the big expectation for Alibaba is that it belongs to a generation of Chinese superstars that chose to list elsewhere, generally either in the US or Hong Kong. Tencent Holdings, China’s biggest social media company, for example, went public in Hong Kong, while JD.com, which rivals Alibaba in e-commerce, is listed on the Nasdaq.

Chinese traders face restrictions on trading stocks overseas, and therefore turn to stocks of Hong Kong-listed Chinese companies available through the Stock Connect.

Alibaba, which last month raised HK$101.2 billion (US$12.9 billion) in the city’s biggest stock offering in nine years, joins the Hang Seng Composite Index on Monday. The index covers a wider array of 481 stocks trading in the city than the 50-member Hang Seng Index. The gauge compiler put Alibaba on a fast track for inclusion.

Being on the broad index is a prerequisite for Alibaba shares to join the Stock Connect.

Other requirements include trading for about seven months and having a market capitalisation of at least HK$20 billion, according to the latest rules by the exchanges in Hong Kong and mainland China.

While expectations are high that Alibaba will be added to the Connect on schedule, it remains a wild card because it takes action by the Chinese securities regulator.

In addition, no company as a secondary listing is available on the Stock Connect. That means the China Securities Regulatory Commission would need to take a special step to allow Alibaba to be bought at home.

The benefits of joining the Stock Connect are clear.

Shares of Meituan Dianping, one of the first two Chinese companies with dual-class share structures to be included in the programme, have climbed 14 per cent since the stock first became available to mainland investors on October 28. Average daily trading volumes of the online service provider from food delivery to ticketing were 35 per cent higher than in the earlier part of the year.

“Joining the Stock Connect will of course be seen as a catalyst for Alibaba in the short term,” said Ken Chen, a strategist at KGI Securities in Shanghai. “Typically, there’s more willingness by investors to invest in companies from their home countries. That is the same for either Chinese or US investors.”

Still, the price gap between Alibaba’s Hong Kong shares and its ADRs will eventually disappear or be very marginal in the long turn, some investors including HSBC Jintrust Fund Management say.

“Room for bigger premiums will be very limited because these companies already enjoy pretty high valuations,” said Chen Yu, a fund manager at the Shanghai-based firm with US$3.5 billion in asset under management who invests in Hong Kong shares through the Stock Connect.

“Given Hong Kong is still a market dominated by international investors, the influence of mainland investors over either the broader market or individual stocks is still limited. Therefore, these companies are unlikely to have long-running and significant premiums simply because of the preference by mainland investors.”

That is starting to be seen with Alibaba.

The premium peaked on November 28, and it quickly narrowed afterwards. Alibaba’s shares closed at HK$197.5 on Friday and its ADRs last traded at US$200 in New York, implying a premium of US$1.80. Each of the surrogate securities represents eight Hong Kong-traded shares.

The ADRs have already risen 194 per cent since the initial public offering in 2014.

The operator of China’s biggest e-commerce platform is not the only company from the Asian nation that trades in both Hong Kong and the US. China Telecom, China Life Insurance and BeiGene are also among Chinese firms with listings in the two markets.

Investment banks still predict Alibaba’s Hong Kong shares will outperform the depository receipts going forward. The Hong Kong shares will rise 19 per cent in the following 12 months, while its ADRs will gain 14 per cent in the period, according to analysts polled by Bloomberg.

“A stock market that is close to the company’s home country or in its home country is usually more helpful for share performances,” said Chen at KGI Securities. “Local investors feel more confident in investing in their home-country stocks as they have more and thorough exposure to trading information.”