IPOs on Shanghai’s tech-focused Star Market, which was hailed by state media as “China’s Nasdaq” after its launch in 2018, are not subject to valuation ceilings © AFP/Getty Images

Initial public offerings in China have undervalued companies by up to $200bn over the past six years, academic research indicates, reflecting a struggle to price listings in the world’s second-biggest equity market.

Limits on the valuations at which companies can sell shares in IPOs on most Chinese bourses mean that groups listing onshore may have raised just a quarter of what they otherwise could have, according to a working paper provided exclusively to the Financial Times by researchers at the University of Hong Kong.

Researchers determined the extent of IPO underpricing by tallying up the early share price gains across almost 1,300 market debuts from 2014 to July 2020 on the main stock exchanges in Shanghai and Shenzhen, as well as the latter’s tech-focused ChiNext market and its small business-oriented SME Board.

They found new stocks jumped on average 300 per cent on their debut following reforms in 2014, compared with just 37 per cent under a previous listings regime.

That underscores the challenges Beijing faces in making its markets more attractive for Chinese companies looking to float, analysts said. US-Sino tensions have made that task more urgent, with $1tn of Chinese equity listings at threat of being evicted from Wall Street under draft US legislation.

“We’ve not moved forward in 20 years — that, I think, is the bigger picture of what this work shows,” said Fraser Howie, an independent analyst and expert on China’s financial system.

Chinese authorities have for decades oscillated between a market-driven regime for pricing IPOs and one in which regulators have a greater say.

For about a decade after the Shanghai Stock Exchange reopened in 1990 following a more than 40-year hiatus, government regulators required most IPOs to price well below their market value. That let retail traders, who could subscribe to IPOs through a lottery system before shares hit the market, benefit from a massive jump on the first day of trading.

But by about 2009 regulators had moved towards an auction-based system for pricing IPOs more akin to those in New York, Hong Kong and London. That meant retail and other investors were far less likely to enjoy big price rises on the first day of trading.

Those reforms drew the ire of investors, according to Andrew Sinclair, a co-author of the University of Hong Kong paper.

“The idea of the IPO pop on the first day, that was something people had come to expect, but that was an artefact of inefficiencies in the market,” Mr Sinclair said. “When it became more efficient that was something that completely broke their expectations.”

China’s IPO pop returns with a vengeance

Following a chorus of criticism by local financial media and academics, which argued that the new system funnelled more money to already wealthy entrepreneurs, the China Securities Regulatory Commission in 2014 in effect imposed a limit that meant most companies could only list their stock at a maximum value of 23 times earnings per share.

Mr Sinclair said that created “a huge incentive to start listing abroad” for Chinese technology groups. Alibaba’s $25bn New York IPO in September 2014, at the time the world’s biggest, valued its stock at a price-to-earnings ratio of 40 times.

China has recently begun to experiment again with market-driven pricing for IPOs. Those on Shanghai’s tech-focused Star Market, which was hailed by state media as “China’s Nasdaq” during its launch in 2018, are not subject to valuation ceilings. Shenzhen’s ChiNext, another tech-centric market, has followed suit.

“Given all the reforms . . . companies can now sell their stocks at more market-driven prices,” said Kinger Lau, chief China equity strategist at Goldman Sachs. “I think that creates extra motivation for Chinese companies to issue.”

Yet listings on Star, which were not included in the University of Hong Kong research, have enjoyed an average day one jump of 160 per cent since the market launched, according to data from Dealogic. Shares in tech group QuantumCTek climbed a record 924 per cent on their debut in June.

By comparison, first-day IPO gains on the Nasdaq and New York Stock Exchange have averaged about 19 per cent and 12 per cent in the same timeframe, respectively.

Listings reforms put a cap on Chinese IPO valuations

Bruce Pang, head of research at investment bank China Renaissance, said that Star IPOs’ pricing reflected a “compromise” between the interests of issuing companies, retail traders and investment banks.

Star IPO sponsors must invest in the companies they bring to market with a two-year lock-up period. That is supposed to ensure bookrunners do not try to offload overpriced shares in shoddy companies to investors, but also incentivises them to price IPOs low enough to ensure a juicy return.

“If you’re a broker underwriting these listings you have to put up some of your money to invest in these companies, so you’d want more upside,” Mr Pang said.

The arrangement is not without its critics, however. Mr Howie, the independent analyst, described it as a “direct conflict of interest”.

“Ultimately it’s the companies themselves which are suffering” due to limitations on IPOs, he added. “Selling two dollars for one dollar never makes any sense.”

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