Mania in a bottle

IPO madness in China stock markets is relative

Will China's stock markets become rational before they become international? The performance of Guotai Junan suggests not.

China's third-largest brokerage joined the Shanghai stock exchange on June 26. Its shares promptly rose the maximum allowed 44 per cent, even as the broader market declined. The online portion of the offering, which accounts for 70 per cent of the shares, was 148 times oversubscribed.

Guotai Junan now boasts a market capitalisation of 216 billion yuan ($35 billion), triple its book value after factoring in the new money. Rivals make that seem pedestrian. The average valuation for the 26 Chinese investment banks and brokerages tracked by Eikon is 5.8 times net assets. US rival Goldman Sachs trades at a comparatively boring 1.1 times.

There is logic, however twisted. Pumped-up equity markets create a virtuous circle: as shares go up, brokerages mint extra fees from trading and interest from lending to stock-pickers. Valuation metrics based not on earnings but, say, the number of accounts a broker has, are becoming popular. Yet only around one in three accounts trade even in a busy week.

Many brokers are also diversifying into asset management, which boosts their appeal. When share prices eventually correct, investors will theoretically use big brokers to divert their money into more stable products.

China's excesses are possible because its markets are still basically sealed. That's how Shanghai-listed shares of CITIC Securities, the biggest broker by net assets, can trade at more than a 20 per cent premium to their equivalents in Hong Kong. But as China's investors get more opportunities to invest abroad, their exuberance will create ructions.

Hong Kong has already had a taste. Mainland investors used the new link with Shanghai to chase companies such as Hanergy Thin Film Power, the shares of which rose to dizzy heights and then crashed 47 per cent in a day in May. Undeterred, the city hopes to create another investment conduit with the casino-like exchange in Shenzhen. Foreign market operators courting Chinese capital may get what they want, but it will come with a lot of froth.