2018.12.17 Jiang You Views:
Recently, to relive share pledge crisis for listed companies, lots of “bailout funds” have come up in the market, drawing much attention and discussion.
Zhang Wei at the Forum of Macroeconomy and Bailout Approaches
Recently, to relive share pledge crisis for listed companies, lots of “bailout funds” have come up in the market, drawing much attention and discussion.
On December 14th, on the forum of “Macroeconomy and Bailout Approaches” sponsored by CoStone Capital, Zhang Wei delivered a speech titled “Bailout Funds — Resource Allocation Under Special Context of Capital Market” and shared his views on bailout funds after going through some basic facts of share pledge in A-share market, bailout funds and M&A of stated-owned enterprises (SOE).
Zhang Wei said that almost each share has been pledged by companies in A-share market, among which 80% are private-sector firms. Many of them are under-capitalized and overleveraged. That is why it’s important to tell which companies are worth a bailout. Otherwise, it may encourage a moral hazard if stakeholders start counting on a bailout when things go wrong.
In Zhang Wei’s opinion, bailouts should reach out to promising firms which are really in need but have strong fundamentals, rather than those rusty ones that face dead ends. Underperforming companies might as well go bust. Meanwhile, it’s even more unsettling if shareholders take bailout as an opportunity to sell their shares.
Zhang Wei has also analyzed current macro-economic situation. He said that there are two irreversible trends due to economic changes. One is about China-US relationship, the other concerns the economic downward trend.
The extracts of Zhang Wei’s speech are as follows:
There are two major irreversible changes this year. Bilateral ties between China and the US are hard to recover in spite of any improvement or deterioration on the surface. It’s not only because of great power competition, but the differences on ideology and political system make the US believe that the way China competes undermines their interests. And the conflict is just getting started.
The second irreversible change is the economic downward trend. After 40-year high-speed growth, China now encounters an economic downturn, which can hardly bounce back in the long run. Private-sector firms, the vital engine for economic growth, now are cash-strapped. All sorts of pressures lead to a sharp correction in the capital market. In the past, share pledges and M&A deals soar as founders seek new borrowing tools. Source of easy money raises risks of an amplified market downturn. Chinese stockholders are ramping up borrowing against shares, driving revenue for securities but creating risk of a chain reaction in the event of a sharp market downturn.
Between 2000 and 2016, when China’s average economic growth reached approximately 10%, stocks fell into a continuous bear market. Stock market has something to do with herd mentality, which also results in share-pledge crisis.
Share-pledge crisis in A-share market
A-share listed firms pledge as many shares as possible. Share-pledge crisis is especially prominent for private-sector firms. According to China Securities Depository and Clearing Company Limited (CSDCC), shareholders in 3485 firms, taking up about 98% Shanghai and Shenzhen-listed firms, had pledged shares worth ¥4.3T by the end of 2018. The market cap of pledged shares accounted for 10% of total shares.
There are too many share pledges, and 2019 will usher in a greater maturity peak of stock pledges. I have recently communicated with many listed companies. Many listed companies deliberately create a shell company on the first day of listing and sold it to cash out. Today, a generally healthy shell company is worth of ¥4B which is just a median, and this is a distorted valuation system.
Think twice before a bailout
Share-pledge crisis pops up due to changes in the market. Statistically, local government has sponsored funds worth of ¥180B, brokers ¥220B, insurance and asset management firms ¥100B. Still, there are different opinions on when to reach out and how to employ.
Shenzhen authorities are quite positive about bailouts. I assume that any bailout decisions that are against the market rules will provoke controversy. As long as you control the shares of a firm, you have to face corporate governance and fulfill the board of directors’ role, concerning corporate strategy, appointments and removals of executives and their salary, financial supervision. It’s impossible for you to stand by and do nothing.
The receivers of bailouts are mostly private firms which do not have strong fundamentals. Therefore, it is risky to take over those under-capitalized and overleveraged firms. An unfair bailout may even cause corporate irresponsibility and “adverse selection”.
Anyone who gets involved in a bailout should keep vigilant and stay away from such risky programs or firms as overvalued firms and those who sell their shares amid a bailout.
A bailout should reach out to those in need
There is much experience about bailout for the Chinese mainland to gain from the US, Japan as well as Taiwan and Hong Kong. In America’s case, it invested $400B in financial institutions to resolve crisis apart from quantitative easing (QE) program. It had some negative impacts and had sharpened the income divide, for which Wallstreet has always been criticized.
We insist on bailing out those promising firms in need. Those terrible firms should be left out to go bankrupt in a sluggish economy so as to carve out some room for companies that are doing well.
The pharmaceutical industry, for example, may only have 1% of 3000 firms that are actually working on R&D. Most of them are more committed to finding alternative channels to do grey marketing. Only after these low-grade companies are forced out can the industry and the market secure a healthy development.
Meanwhile, we use several indicators such as P/E ratio, ROE and the growth rate of net profit in the past three years to screen companies which need bailouts. There are 373 qualified ones that are worth investments.
However, there are other things that can also sustain a company through an economic cycle. Huawei poured ¥89.7B in R&D, accounting for 27% of its revenue. Although it entered telecommunication industry because of “ignorance”, it makes painstaking efforts with purpose and keeps its course, making it through the whole industrial and economic cycle. We prefer to look at a company from historical perspective and take a strength-based approach to find target companies for bailouts.
Source: China Fund
Rewritten by Lu Ying; Edited by Jiang You
The year 2019 marks the fortieth anniversary of China’s Reform &Opening-Up, once again, we meet at the turning point of history. What’s the next step for the game, is there any clear guidance? The answer is affirmative.
Our country is enjoying a good momentum of development, which does not come from the Washington Consensus nor the Beijing Consensus. China’s experience has proved that both the visible hand and the invisible hand are crucial: the visible hand, stands for the government-led reform, and would yield benefits for reform and opening up; the invisible hand, stands for the Marginal Power represented by the private sector, and would improve economic efficiency and tax collection, create jobs and employment opportunities.
Provided that we want to protect and expand the benefits form reform, three simple but mandatory agreements are to be made and followed: No.1 Private ownership must be recognized, protected and treated equally with public ownership constitutionally, both ownerships are scared and inviolable;No.2 Make further clarification of the principal position of market economy, “deepen economic system reform by centering on the decisive role of the market in allocating resources”, as President Xi addressed in the third Plenary Session of the 18th CPC Central Committee;No.3 Implement the guiding principles of “comprehensively promoting law-based governance” of the fourth plenum. The rule of law is essential for economic growth, irreplaceable to protect private ownership, and necessary to encourage innovation and entrepreneurship.
Above are three rules for us to avoid falling into the Middle-income Trap. Assuming that we are breaking systematic barriers to private enterprises’ participation in market economy, and boosting innovation and entrepreneurship of our society, then we are heading towards a promoting direction. We are marching in the path of light, regardless of the ups and downs of Sino-US relationship, the drop in GDP growth rate, or the monetary policy.
These principals also apply on knowing how better to run a business: don’t be hedged by rules and regulations at the beginning, pay more attention to your survival, and you’ll learn more when you start your second business.
For many years, Huawei has been the only Chinese company on the list of the Top 50 R&D Spenders. Regardless of the economy and its income, what Huawei has been doing is investing in its future, dedicated to R&D, continuously and resolutely. This provisional work underscores Huawei’s accomplishments, making Huawei anindustry leader.
So, there are standard answers on how to run a company,which could be summarized as concentration and professional dedication, continuous investment on innovation and trying harder in R&D. Entrepreneurship is also important, every single company needs entrepreneurs to push aside all obstacles and difficulties, to implement strategies and ideas. We, as investors, are destined to look for such outstanding entrepreneurs and their companies, invest in them and partner with them.
At this key point of history, a country, a company, or asingle individual, will all need to find the right path. Four decades after the Reform and Opening-up, it’s time to learn from our experience and stop “wadding across
