Oversupplied

When China XD Electric, the country’s largest manufacturer of power distribution equipment by sales, ended its first day on the Shanghai Stock Exchange down 1.4% from its initial public offering price, the occasion marked another sobering warning for future mainland share listings.

In a market where stocks have frequently jumped more than 100% over their offering prices, a single busted IPO might be seen as an isolated case of the market responding to a bad company or initial overpricing. Since the China Securities Regulatory Commission (CSRC) lifted a ban on new IPOs last June, China’s exchanges have been active even in the midst of global apathy toward new equity issuances.

However, assigning the blame solely to XD Electric would ignore a string of recent Chinese IPOs that have fallen in the periods since their debuts, including heavy machinery manufacturers China First Heavy and China Erzhong. Another warning sign came when Huatai Securities, a mid-sized brokerage, fell short of its US$2.5 billion IPO fundraising target. Only one other company – First Heavy – has failed to reach its target in at least a year.

The evidence indicates that China’s IPO market has finally hit a saturation point. The Shanghai Composite Index (SCI) is already down nearly 8% this year, and higher reserve requirement ratios imposed by the People’s Bank of China are expected to push it down further. The abundant liquidity that saw the SCI gain 80% over the course of 2009 is now drying up; there is less cash out there to invest in equities.

The CSRC has already suggested that it will adjust IPO pricing rules. "Some institutions are simply profit-driven and are not responsible when proposing a price," said a CSRC spokesman at a January seminar, where he blamed ineffective pricing mechanisms for overvaluations. Amid continued market weakness, some feared that the CSRC would suspend approval of new IPOs until new price-setting regulations could be implemented.

The recent spate of difficult listings will only discourage the market’s appetite and lower future valuations of comparable companies. At the same time, they might encourage more accurate pricing in future offerings, reducing the regulator’s role in taming overinflated values.

While there is hardly a shortage of Chinese firms anxious to raise capital, the weak market has led more cautious players to modify their capital-raising strategies. Agricultural Bank of China, the nation’s third-largest lender, announced that it has delayed its long-planned IPO due to the current conditions. The cooling period will also delay the progress of foreign listings on Chinese stock exchanges.

The CSRC’s next step will depend upon the future performance of China’s stock exchanges and new listings. But in the case of poorly performing IPOs, the invisible hand of the market may finally be allowing oversupply to rein in overpricing.