Great Chinese dream: myth or reality?
Maybe just another BRIC in the wall…
A RECENT COVER of Time magazine labelled China the “Dawn of a new dynasty”. It’s hard to disagree. China has become the world’s industrial and commercial giant, propping up some smaller countries’ economies (and commodity prices) through its aggressive import programme.
Not surprisingly, foreign investment into China has been huge – US$53bn (R384bn), according to the latest figure for 2005. There’s no disputing the growth potential in China, but some seasoned investment professionals in SA are questioning what they see as a blind, headlong rush into Chinese assets and companies by Western investors. There are dangers they feel could end in tears.
But so what if rich American and European investors and companies are piling into China? Well, it’s also an issue for South African investors, many in awe of the Chinese story and being enticed into BRIC, BRICK and BRICKS (Brazil, Russia, India, China, Korea and South Africa) funds that include Chinese equities.
“It always bothers me when everyone sings from the same hymn book. Investments in China started worrying me last year,” says Rowan Williams-Short, investment director at Nedgroup Investment Advisors in Britain.
Williams-Short recently returned to SA to open his own asset management business, Orthogonal Investments (the maths concept is complicated, but it basically means “Don’t put all your eggs in one basket”). But Nedgroup has asked him to stay on as a consultant.
During his two years overseas he says he visited more than 1 000 asset managers worldwide and gained a detailed insight into global investing. Says Williams-Short: “The increasingly hackneyed growth stories concerning China and India – replete with a new phase Chindia, often a harbinger of hubris – seem to have become the staple diet of just about every investment conference over the past few years.”
A selection of his concerns with regard to China include: • The economy is still centrally controlled. For example, a maximum price:earnings multiple for initial public offerings (IPOs) was set in December 2001. The strong implication is that that invites earnings manipulations to match the set p:e. Quoting Marathon Asset Management, Williams-Short says the percentage of Chinese IPOs whose stated return on capital peaked in the year preceding the listing (before proper scrutiny by respected auditors and before fuller disclosure requirements) is 100%. • H shares – in itself a concern, as these are the shares available to foreign investors and not the regular ordinary shares. WilliamsShort likens it to our old financial rand system, but adds the change in net income margins of such H shares in the four years following new listings has been a negative 40%. His conclusion: “It would appear that new investors are being duped into giving credence to puffed-out pro forma financial statements.” The annual new power generating capacity needed to sustain China’s recent growth rate exceeds the entire installed capacity in Britain. (And we think we have problems with Eskom’s required capacity.) “Such tangible prerequisites, easily enough discovered by induction, tend to escape the notice of forecasters, who rely mostly on extrapolations of recent trends.” Given the vastness of China and its massive population, accurate calculation of GDP must be more difficult than in most countries – yet each quarter China is among the first countries to release a GDP growth number. “You could be forgiven for suspecting that rough estimations and smoothing may be used,” he says.
Piet Viljoen, of RE:CM, has also taken a concerned look at Chinese equities, focusing on recent bank IPOs. As part of a larger study concerning “very large, very overpriced IPOs” in global markets, the research on the RE:CM website identifies Chinese banks as one of three current world investment themes (the others are infrastructure plays and private equity).
The last two sound very familiar in SA’s investment landscape; but on Chinese banks, RE:CM notes the rise of 2,5bn new consumers in China (all of whom need a bank loan). That makes it not hard to understand the attractiveness of such assets.
“Currently, Chinese banks are enjoying a period with a good fundamental backdrop: their huge bad debts have been removed by the government, their equity recap via the IPO mechanisms has allowed them to grow their loan books rapidly (again) and globally interest rates are low. But does the valuation stack up?”
The answer seems clear from the averages that RE:CM has compiled for large developed market banks, SA and Chinese banks in the table below.
At face value, Chinese banks look fairly
expensive, says RE:CM. However, it notes that the numbers don’t take potential growth rates into account. “But then again, nor do they take potential bad loans that are currently being written either.”
The asset manager’s conclusion is that it’s no surprise Chinese banks are issuing record amounts of stock to investors and are being paid a nice price. Needless to say, Viljoen isn’t investing in any of these new listings.
Williams-Short says even for investors loath to believe or pay heed to his concerns listed above, they “need to consider an issue that they might normally take for granted – that of basic regulatory protection for shareholders”. He quotes some excerpts taken from the “small print” of a respected fund-offering document investing in Chinese equities. • “…suitable for investors who are willing to withstand the total loss of their investment…” “Companies quoted on Greater Chinese stock exchanges are exposed to the risks of expropriation of assets or nationalisation.” • “…should any tax be payable retrospective-
ly, the net asset value will be adjusted to the extent that existing shareholders are liable.” Williams-Short adds that while he’s prepared to contemplate that he might be wrong or misguided about the extent of China’s economic growth, that’s less interesting to investors than the debate on the merits of buying listed Chinese shares.
And Williams-Short says Chinese equities are “totally inappropriate” for South African investors. “Emerging market investments make up about 10% of the world’s total investments. SA is around 1%. Do you want to diversify from that 1% into the other 9%? It doesn’t make sense.”
He says while investment dangers may not be as extreme in India as in China, he’s also worried about India “because it’s the flavour of the day”. It’s all the hype that concerns Williams-Short, and he has seen it before: south-east Asia in the latter half of the Nineties (the Asian Tigers), Y2K, the TMT meltdown.
He quotes Jonathan Anderson, chief Asian economist at UBS, on the Chinese economy as “propped up by a potent cocktail of free capital distorted resource allocation”. Says Williams-Short: “The crazed rush by institutional fund managers to offer retail products investing in Chinese equities – BRIC, BRICK and BRICKS – should sound the largest alarm bell of all.”
And he has told a large investment conference that it’s enough to make a cautious SA investor “shit a brick”.
AVERAGEGE RATIOS AND RETURNS FOR:Source: RE:CM
A harbinger of hubris.
Not investing in Chinese
banks. Piet Viljoen