The GEM’s Illiquid Fate
techbuddha.com
In its one year of existence, Hong Kong’s Growth Enterprise Market, has listed 56 companies and raised a grand total of US$ 2bn.
As of year end 2000, the GEM’s market capitalization was US$ 8.65 bn, insignificant beside the HK Stock Exchange’s US$ 750 bn market value. Meanwhile, the average free float of these companies was about 18% and the average daily turnover for December 2000 was US$ 14.7mn, half of which came from one stock. That’s about half the volume of the Jakarta Stock Exchange on a bad day. What’s wrong with this picture?
Maybe part of the problem is a “poor environment.” Low liquidity and a dim outlook for technology startups. But that is a bad argument: low liquidity only affects companies that still haven’t raised their capital. GEM companies, on the other hand, are in the land of milk and honey. They’ve raised their public funding and are sitting on the proceeds. That’s as good as it gets.
We’ll just have to be brutally honest, then. GEM companies are penny ante businesses trading in an illiquid market. Put a gun to our collective heads and there is only one GEM-listed stock that we’d consider buying in the best of times: Phoenix Satellite Television (8002 HK).
How Did the GEM Become So Illiquid?
Illiquid markets don’t become illiquid by mere coincidence. They become illiquid for three main reasons: lack of trust, lack of quality, and volatility. Lots of markets with the latter two characteristics manage to function, but the first is essential if a market hopes to survive and grow in the long run.
Trust, in turn, is all about regulation. Can you trust the market regulators to be impartial, to enforce certain standards, to ensure a minimum degree of protection of shareholders’ rights? To this basic list, we would also add the question: are the regulators building a market that will survive short term market fluctuations?
On the trust front, GEM regulators have let us down in very short order. Most visibly, they betrayed the raison d’etre of the entire market within its first four months of existence by allowing deals like Tom.com (8001 HK) and SUNeVision (8008 HK) to take place. These two issues not only flouted the founding principles of the GEM market but are also prime examples of the oligopolistic, speculative mindset which limits the overall growth of the Hong Kong stock market.
Without dwelling too much on the companies themselves, let’s quickly consider the implications of the Tom and SUNeVision listings. Both had politically connected and financially strong parents. Neither had any operations or business plan whatsoever and relied on their investment bankers to draft their marketing materials, creating the pie in the sky for speculators.
One year later, these companies are laughingstocks and an embarrassment to their peers: they still lack business plans, they still have no revenues to speak of, and SUNeVision, for one, reports gross losses. Put another way, SUNeVision is in the business of selling dollar bills for fifty cents. Companies like this do not a NASDAQ make.
The Dream
The GEM was established in order to give small, rapidly growing businesses, particularly those in the technology sector, access to capital. It was also intended to attract the best startup businesses in the region to the Hong Kong market, becoming a regional substitute for the NASDAQ market. Asian companies that listed on the NASDAQ, it was thought, became less liquid and less widely held over time, reducing their attractiveness to investors and raising their cost of equity over time.
But did this market really provide young, growing companies with superior access to capital? Not in the minds of Asia’s most visible new economy startups, companies such as Sohu, Sina.com, and China Netcom.
Originally slated to list on the GEM market, these companies have opted to look overseas for public funding. They would rather be small, Asian fish in a big American pond than large, toxic fish in Hong Kong harbor.
The Chinese Are Defecting
The defection of these companies is especially worrisome because they all share one thing in common: they are all Chinese. Virtually all of the promising technology companies on the GEM have promise because they are mainland companies or focus on the Chinese market. Take those away and the GEM is a sad story indeed.
There has been a brain drain of good companies away from the “small board” and toward the NASDAQ. This reinforces our belief that the biggest enemy of the Asian startup is not capital shortage, but a lack of sophisticated investors.
Inferior Shareholders Can Destroy a Decent Company
The investors in a company’s IPO set the stage for its trading behavior, its pricing, and its liquidity in the market. Of course, the best way to get the right people to invest in your deal is to get the right underwriters. The right underwriters bring in the right investors due to superior distribution channels and their close links to the institutional investment community.
Institutional investors such as insurance companies and mutual fund managers tend to hold for long periods of time and to take sizable positions in companies, creating a stable underpinning of core shareholders. Retail investors, on the other hand, tend to hold for short periods of time and to trade on newsflow. Lots of them make a stock very volatile.
And volatility is the enemy of the forward-looking CFO. Volatility raises a company’s theoretical cost of capital by increasing its “beta.” A high beta, or multiplier of a company’s equity risk premium, can double or triple a company’s cost of equity. This both lowers the company’s valuation in public markets and makes it much harder, and more expensive, to raise additional equity.
On this measure, GEM companies have neither good underwriters nor quality shareholders. Most GEM deals are underwritten by third tier houses such as Core Pacific Yamaichi or, at best, BNP Prime Peregrine and very few GEM roadshows receive audiences from top fund managers such as Capital, Invesco, or Fidelity. The deals are too small and the companies often do not stand to scrutiny.
The Fate of the New Market
The GEM’s descent is an allegory of greed and comeuppance. The market is reaping the effects of its caveat emptor marketing pitch. It is indeed a “buyers beware” market and, lo and behold, the people are being wary.
Its fate is not unique. All over the world, new markets are facing similarly rapid declines. Italy’s Nuovo Mercato and the Frankfurt Neuer Markt have plunged about 70 percent from their peaks last spring, and the Nouveau Marché in Paris is down 60 percent. The smaller new markets of Madrid, Amsterdam and Brussels are also facing obscurity.
The GEM will survive if and only if it manages to attract more Chinese stocks to pursue GEM listings. Only these companies fit the original criteria of the new market: growth and lack of access to capital.
Chinese companies, however, face a strong pull from a new bourse soon to be established in Shenzhen, as well as from the NASDAQ overseas. The GEM’s potential attraction? Access to investors and lower listing costs. In order to deliver these things, however, Hong Kong’s new market will have to shape up, and quickly!
Courtesy: Erlangshen |
