21 March 2019
Chinese smartphone maker Xiaomi has failed to live up to all the hype that it had built up earlier about its Hong Kong IPO. Photo: HKEJ
Chinese smartphone maker Xiaomi has failed to live up to all the hype that it had built up earlier about its Hong Kong IPO. Photo: HKEJ

Xiaomi’s deflated IPO: What are the lessons?

Xiaomi, Hong Kong’s first listing with multiple-class share structure, made a weak trading debut on Monday.

One can only speculate now as to whether the tepid investor response was due to bad timing for the mega-IPO, given the escalating trade war between the US and China and a generally weak broader market environment.

The Chinese smartphone maker had reportedly planned a blockbuster offering at the beginning of the year, when the Hong Kong stock market was off to a bullish start, with the Hang Seng index setting a new all-time high at 33,000 points and crises such as those involving ZTE and Rusal yet to break out.

Before the Sino-US trade fight escalated, China and Hong Kong seemed to realize that they can’t afford to “lose” the Chinese high-tech firms to US stock exchanges.

Considering that, Hong Kong started a big push to lure Chinese tech firms with a new regulatory regime that allows companies to issue shares with weighted voting rights (WVR) and more lax listing rules for biotech companies at pre-profit/pre-revenue stages.

To compete, China’s securities regulator rolled out Chinese depositary receipts (CDRs), hoping to lure tech giants such as Baidu and Alibaba, which have listed in stock exchanges overseas, back to home market.

Originally aiming to become the first entity to sell CDRs, Xiaomi abruptly scrapped the China securities issuance plan, probably due to issues related to its business model, valuation and the Chinese market environment, casting doubt on Beijing’s efforts.

There are many reasons the technology majors, or “unicorns”, should stay in Hong Kong or China’s A-share market. The single most important reason is that these “fresh faces” can bring new energy to the somewhat old-fashioned stock markets in the country.

While many see Shenzhen, the birthplace of tech firms like Tencent, Huawei and DJI, as China’s Silicon Valley, and consider the city’s ChiNext as “China’s Nasdaq”, it must be pointed out that in the last decade or so, most of China’s best tech firms had opted for listing in the US, except Tencent (which chose to list in Hong Kong). As for those listed in Shenzhen, even though there are some good companies like Hikvision Digital Technology and BGI Genomics, the majority are not in good shape, while also being overpriced.

I had repeatedly pointed out in previous articles that stock markets in China and Hong Kong have a relatively low equity risk premium (ERP), which is a major component used in stock valuation. The past ten years saw an ERP of negative 11 percent for Shanghai A-Share Stock Price Index, and about zero percent for Hong Kong stock index. In comparison, the S&P500 recorded a favorable equity risk premium of about 6.7 percent.

With a low or even negative ERP, investors would not be interested in participating in the market. That may explain why most of the Chinese capitalists are flocking to the “unicorns” in the country, investing in the primary market, rather in the secondary (open) market.

In the project-based, primary market investments, there are quite a few bright examples of multi-bagger returns, such as Alibaba, Tencent, and even Xiaomi (Xiaomi founder Lei Jun claims the firm’s early investors reaped an amazing return of more than 800 times.)

That said, there are lots of untold failures in this kind of risk-intensive, low-liquidity investment. The return figures in China’s primary market investment are not easy to find. As a comparison, among the investments made by VCs in the Silicon Valley, only one out of ten cases can exit through successful IPOs, about two or three cases would make an exit via a trade sale, while the remaining probably would incur a loss.

That is the reason why non-professional investors in the US rarely invest in a single VC project, they would invest in VC funds with diversified investments, and the investment ratio will generally not exceed 10 percent of all their equity investments, which accounts for 60 percent of the wealth of the high-net-worth individuals in the US.

Valuation is another major issue for investing in Chinese “unicorns.” Take Xiaomi as an example, whose market valuation was cut by almost half from the US$100 billion touted last year. We should note that the smartphone maker was still losing money last year, and its IPO price of HK$17 a share translates to a forecast price-earnings ratio of over 50 times in 2019, while Apple, the world’s most valuable company, is trading at about 16 times trailing earnings.

Xiaomi categorizes itself as an “internet firm”, However, sales of low-margin hardware account for 90 percent of the firm’s revenue. In contrast, Apple earned over 15 percent of its revenue from software and services.

While some believe Xiaomi’s dominance in India can help it grow into larger valuation, one should bear in mind that the consumption power in the Indian smartphone market is still relatively small, and the average smartphone price in the Indian market is much lower than that of China.

In addition, though Xiaomi’s business may not be as sensitive as that of telecoms equipment suppliers ZTE and Huawei, it is still a matter of concern amid the China-US trade and tech fight.

“Unicorn”, referring to non-listed businesses valued at more than a billion dollars, was a term coined by Aileen Lee, a venture capitalist in the US back in 2013. At that time, unicorns were truly rare, with only 39 of them worldwide (all located in the US). But to date, the total number of unicorn companies has surged to about 300, with about 164 of them located in China and 132 in the US.

Some see a unicorn bubble as the companies may be getting overvalued by VCs or investors. If that is true in the US, we should brace for an even bigger bubble among Chinese unicorns.

This year, tech unicorns that headed to IPOs in the US, like Dropbox and Spotify, delivered a strong performance, as was the case with some Chinese unicorns listed in there, entities such as Bilibili, and Huya.

But among those that were listed in Hong Kong in the recent past, several firms, including Ping An Good Doctor, Razer, and Yixin Group, have seen their shares fall way below their offering prices.

Why are the big tech listings in Hong Kong faring much worse than those in the US? There are three possible reasons.

Firstly, in the past two years, the performance of Nasdaq index in the US has been far better than the Hong Kong key stock index. Secondly, investors in the US market have a better understanding and acceptance of new-economy firms. Thirdly, it may be that the valuations of Hong Kong tech listings have been more aggressive than those in the US.

And it should be noted that the mentioned tech listings are examples before Hong Kong’s new weighted voting rights structure became effective. Now, under the new listing regime, Hong Kong market is hungrier than ever before, willing to try every single way and even lowering the barrier in an attempt to lure tech unicorns to the city’s bourse; earnings requirements for listing exist in name only.

In the second half of the year, there are nearly 90 companies queuing for IPOs, such as Chinese live-streaming platform Inke, the mainland’s largest real estate agency E-House China, food delivery and internet giant Meituan Dianping, and biotech companies like Ascletis Pharma and Innovent Biologics. These companies filed for Hong Kong IPOs with aggressive valuations, reports suggest.

I support the idea of good companies coming to Hong Kong and China’s A-share market for listing. But I am of the view that that the Hong Kong market does not have to give up the listing standards it deserves, let alone its responsibility of protecting investors.

On the enterprise side, I think companies and startups should not be too short-sighted on the valuation strategy. An over-priced IPO would eventually jeopardize the firm’s long-term gains. 

The full article appeared in the Hong Kong Economic Journal on July 10

Translation by Ben Ng

[Chinese version 中文版]

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Eddie Tam is the founder and CEO of Central Asset Investments.

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