China's wannabe Nasdaq works better on paper

John Foley

China’s new growth-stock market has made quite an entrance. Shares of the 28 companies on Chinext, Shenzhen’s answer to the US Nasdaq, all at least doubled during their first half-day of trading. They were already priced at 40 times this year’s forecast earnings on average, compared to the 30 multiple at which Shenzhen’s main index trades. Chinese investors have got what they needed least: a chaotic hive of overvaluation.

In theory, a growth market makes sense for China. Savings could find their way to technology and services firms, which often miss out on government largesse and bank lending. That neglect belies their importance promoting innovation and driving consumption. Companies, most of them high-tech, instead tap overseas markets – which does nothing to help China allocate capital efficiently.

But in practice, Chinext looks like too much, too soon. China’s main markets are already more volatile and risky than their foreign counterparts. Growth-stock entrepreneurs are untested when it comes to public-market corporate governance, to say nothing of the smaller underwriting firms that back some stock issues. Chinext runs the risk of going the way of Germany’s Neuer Markt, which was plagued by scandal before it eventually closed.

Germany – like Hong Kong, Canada, the UK and Japan, which all established separate growth markets – at least had something China doesn’t: a deep, developed capital market. In China, even shares of large companies are in short supply because small free-floats are the norm. Initial public offerings typically attract double-digit oversubscription rates, such is the scarcity of new investment opportunities. Some Chinext stocks were oversubscribed more than 100 times, say people familiar with the situation.

Meanwhile, Chinese investors are struggling to access more of what they really need – bigger companies with proven track records. The main markets are restricted by a regulator that hand-picks listings based on policy objectives. Removing the red tape for more mature companies ready and willing to float, and speeding the release of state-owned untraded shares into the market, would genuinely advance Chinese capital markets. Instead, the cartoonish outperformance of Chinext is more likely to set them back.

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