Chinese initial public offerings proved to be the hot ticket item in the US ahead of the holiday season. According to Dealogic, 38 Chinese companies raised a total of US$4 billion through US listings in 2010, and many more plan IPO road shows in the first quarter of 2011.
Several offerings were massively oversubscribed and the companies followed up with extraordinary trading debuts. Dangdang (DANG.NYSE), the country’s largest online book seller, posted a first-day gain of 87%, followed by online video site Youku.com (YOKU.NYSE), which saw its stock soar 161% on its first day. Prior to Dangdang’s listing, four Chinese dotcoms had gone public in New York in 2010, with an average first-day return of 57%. ChinaCache International Holdings (CCIH.NASDAQ) was the other standout performer, surging 95%.
All these companies have high price-to-earnings (P/E) ratios: Had Dangdang priced its IPO at the low end of the price range, it would still have been valued higher than Amazon.com (AMZN.NASDAQ); as of mid-December, the Chinese firm’s stock was trading at a P/E of over 1,100.
Yet investors haven’t been put off. With the US and European economies still floundering, China, as well as several other smaller emerging markets, is increasingly a preferred option. It is perfectly understandable that investors would want more China exposure, particularly to companies that target the country’s expanding consumer sector. In the internet segment alone, broadband users, online gamers and advertising revenue are still growing at double-digit pace. It didn’t hurt that Youku and Dangdang both have familiar US analogues: Youtube and Amazon, respectively.
Baidu.com (BIDU.NASDAQ), the Chinese Google (GOOG.NASDAQ), which listed five years ago, remains the high-water mark for Chinese internet stocks. Opening at US$12, the stock rocketed 360% on its first day and now trades around US$100 a share. Youku’s opening day gain was the biggest seen since Baidu and investors are keen to see the subsequent growth story repeated.
But the market is as indiscriminate as it is hungry. Baidu’s success rests on strong financial performance: Over the four years since its listing, the company has seen net income grow 534%, 108%, 67% and 42%. It is questionable whether others can do the same.
Dangdang’s revenues jumped as China’s online sales more than doubled in the first half of 2010. However, the company was taking losses until 2009, when it finally posted a net profit of US$2.5 million. Dangdang should benefit as e-commerce continues to rise, but it warned of margin squeeze as product lines expand.
The positive vibes about Youku, meanwhile, appear to be largely predicated on the 74% year-on-year expansion in the Chinese online video market in 2009. In fact, the company has posted losses of up to US$30 million in each of the last four years as the costs of bandwidth and content licensing outstrip advertising revenues by a consistently wide margin. This is unlikely to change: Youku plans to use the proceeds from its listing to invest more in bandwidth and content, enabling it to lose more money faster.
The hysteria has eased since the companies’opening-day heroics. Having closed at US$26.95 on its first day, Dangdang has since slipped to around US$23, still more than a 40% premium over its IPO price. Youku, which ended its first day at US$33.44, was down to US$30 a week later, but still up nearly 135%. Cynics might suggest that the entrepreneurs and sponsors have succeeded in making their millions while the traders have had their opportunity to short the market.
But what of the longer term prospects for these companies? Both Dangdang and Youku will have to justify investors’faith come first-quarter results. For Youku at least, it’s difficult to see how management can deliver. The company may also be in for a bout of bad PR as major entertainment brands seek damages over top-grossing TV series and movies that have found their way online without licenses.
Chinese online fashion retailer Mecox Lane (MCOX.NASDAQ) already knows the damage that unwanted lawsuits can cause. Having climbed 57% on its debut in October, the company saw its stock plummet after shareholders took action over an alleged overstatement of projected results and a failure to disclose the impact of increased costs.
The message for investors is clear: Beware the hype about Chinese IPOs. Investment bankers are all too ready to regurgitate impressive industry growth numbers and even more dizzying projections for future expansion. Sometimes this is justified – many Chinese firms that have listed in the US are profitable and low on debt – but sound bites don’t necessarily tell the full story. China’s internet industry, where users are plenty but monetizing them is hard, is a case in point.
And for every Youku, there is a Sky-Mobi (MOBI.NASDAQ). The company, which runs China Mobile’s (CHL.NYSE, 0941.HK) app store, fell 25% when its stock began trading in December. It was the biggest first-day loss in the US in three years.