China's stock market binge
BOOK REVIEW
Privatizing China by Carl E Walter and Fraser J T Howie
Reviewed by Gary LaMoshi
Readers considering playing China's stock markets will get more than their money's worth by page 4 of Privatizing China. In other stock markets, the book explains, shares represent the holders' right to ownership in the company and a portion of its profits, as well as the company's obligation to stockowners in these areas. That's not the case for equity with Chinese characteristics, though.
In China, the stated objective of securities markets, at the start at least, was to promote operating efficiencies in SOEs [state-owned enterprises] still controlled absolutely by the state. It is, therefore, entirely unclear just what securities did, in fact, represent, other than the opportunity perhaps to profit from trading and to receive a dividend.
Ownership of the company? Forget it. Protection of your investment through an independent board of directors? Read on:
For the companies, there still seems to be no sense of obligation to minority shareholders; only to the state, if at all. In China, the markets are operated by the state, regulated by the state, legislated by the state, and raise funds for the benefit of the state by selling shares in enterprises owned by the state. In the entire system, the only things that do not belong to the state are the actual money, or capital, put up by presumably individual investors, and the market itself.
Investors would be wise to recall the African proverb: "When elephants romp, the grass gets trampled." Undoubtedly there is a Chinese equivalent; luckily for the promoters of China's stock markets, most investors in mainland companies seem to have forgotten it.
Privatizing China is an intelligent, devastating examination of, as its subtitle says, China's stock markets and their role in corporate reform, as well as a comprehensive reference on the development of those markets. Investment banker Carl Walter and market expert Fraser Howie point out that the financial markets fall far short of that originally stated government goal of reforming state enterprises. Listing companies on stock markets has also failed, despite folklore to the contrary, to transform China into a nation of shareholders or create a financial mechanism by which individuals or institutions, such as insurers and newly private pension funds, can reliably invest to support and profit from China's future economic growth.
The book's clear-eyed analysis of economic issues in China is as welcome and useful as it is rare. China remains a difficult place to live and work, so Westerners who stick around long enough to gain expert knowledge are generally those who find China charming or fascinating; for the most part, they drink the Kool-Aid. As a result, the overwhelming majority of experts tend to be enamored with China, see the bright side of the story, and tell it sympathetically.
Walter and Howie, each with more than a decade working in Chinese equities, may love China, but their tough love isn't blind to the inconsistencies, exaggerations, peculiarities and outright frauds that are as much a part of Chinese stock markets - and most aspects of China's so-called economic miracle - as the annual gross domestic product (GDP) growth numbers.
China's stock markets evolved from grassroots financing schemes, not a grand design from Beijing, and grew largely because of promotion by local government champions in Shanghai and especially Shenzhen. It wasn't until 1996, 12 years after the first over-the-counter market began, that the central government took control of equity markets. Nevertheless, Beijing's political winds dictated the limits of stock-market development and, from the beginning, the state's roles as owner, regulator and politician have often conflicted.
The fundamental, unresolved contradiction between China's economic and political aspirations - the state, as enterprise owner, wants foreign capital without ceding control - remains at the heart of the failure to create properly functioning equity markets. Instead, China's stock markets, according to the authors, are little more than funny-money casinos built on foundations of sand and populated by manipulators.
The book explodes several myths about China's stock markets that distort Western views. Analysis of official claims of 66 million Chinese stockholders reduces the actual number to between 500,000 and 2 million active investors. That figure matters, the authors note, to indicate the extraordinarily limited reach of the stock-market experiment, its susceptibility to manipulation, and the (intentionally?) exaggerated official fears of social unrest that secure government complicity in keeping share prices inflated. The authors document numerous cases of stock manipulation as well as citing the Ministry of Finance's 1999 finding that 89 percent of listing companies cooked their books to inflate performance.
Similarly, under close scrutiny, the official US$503 billion combined capitalization of the Shanghai and Shenzhen markets tallies closer to Malaysia's $129 million market cap. En route to that reduced figure, Walter and Howie brilliantly dissect the seductively simple questions of what stock prices in China measure and how they measure it. As with various methods for hitting the knuckleball, none of the China valuation formulas work.
Hong Kong-traded H shares are generally priced 50-90 percent less than their Shanghai or Shenzhen A share counterparts, even though each of those different shares represents the same stake in the same company. The price difference is due, at least in part, to the lack of alternatives for mainland investors, as well as various trading quirks.
A controlling stake in every publicly listed Chinese company is reserved to the state, and those shares cannot be traded except through private placement deals among state entities. At least in theory, and generally in fact, there is no possibility that shareholders can benefit from a takeover, which in other markets would include a premium for control. However, when Chinese state shares are traded, the prices are far below the public counter quotes, but those trades don't impact public share prices. Generally, public shares are priced as if state shares don't exist, leading to market crashes whenever additional state shares hit the public market, or even are rumored to.
Above all, the authors emphasize that the stock market in the People's Republic of China (and listings of Chinese companies on foreign markets), a revolutionary idea in the PRC context, continues to evolve as it has for nearly two decades. Walter and Howie say they are optimistic about the potential of Chinese equity. At this stage, Privatizing China is the best investment you can make in Chinese stocks, a sure bet to inform and entertain while saving you from playing markets that are still just a gamble.
Privatizing China by Carl E Walter and Fraser J T Howie, John Wiley & Sons, Singapore, 2003. ISBN: 0-470-82120-5 (paperback). Price: US$27.95, 296 pages.
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