Star Market’s success is reshaping how companies go public in China, writes Tim Human
In 2020, an equities market that had been in existence for less than two years attracted nearly half of all IPO proceeds in mainland China. Star Market – or, to give it its impressive full name, the Shanghai Stock Exchange Science and Technology Innovation Board – has a growth story as remarkable as the ‘new economy’ companies that flock to its doors.
The market has also drawn scrutiny for its dramatic first-day trading gains and wild price swings. But given the huge returns on offer for investors, and high multiples on offer for companies, there are few complaints to be heard.
China’s Nasdaq Prior to Star Market, going public in mainland China featured a long wait and weighty restrictions. Companies needed approval from the China Securities Regulatory Commission (CSRC), which could take more than a year. In addition, minimum requirements on net profits, cash flow and assets meant only mature businesses were able to list.
Ringo Choi, EY Asia-Pacific
Policy-makers recognized that the system was not fit to support the fast-growing companies in emerging sectors – such as advanced IT, bioscience and renewable energy – that they expect to power the country’s future economic growth. The creation of Star Market marked a fresh approach.
First announced in November 2018 by President Xi Jinping, the board operates a registration-based IPO system. Companies need only register with the regulator while they wait for the go-ahead from the Shanghai Stock Exchange (SSE), cutting waiting times down to several weeks. The new system not only speeds up the listing process, but also helps companies know with greater certainty when they can access capital, says Ringo Choi, IPO leader for EY Asia-Pacific.
Star Market also brought in looser listing standards. Companies can go public with dual-class share structures and no longer need to be profitable – changes designed to make room for early-stage tech firms. Finally, the market has much greater freedom in setting a company’s price. Unlike Shanghai’s main board, there is no limit on price rises in the first five days of trading. Regulators have also dropped the practice of setting a cap on the price-earnings (PE) ratio at the time of listing.
‘Now companies get the range from doing a roadshow with institutional investors,’ says Choi. ‘This is why the PE multiple for the Star board is so much higher than the main board in Shanghai for the IPO pricing.’
In 2020 the average PE ratio for IPOs on Star Market was a lofty 72, compared with 23 for the Shanghai main board, according to data from EY.
Burning bright Star Market officially launched in June 2019, with 25 companies admitted to trading the following month. Less than two years later, it has become the dominant venue in mainland China for raising equity capital.
In 2020 Shanghai’s growth board accounted for 47 percent of IPO funds raised and 37 percent of volume for the whole A-share market, which refers to companies listed on mainland exchanges with shares traded in renminbi. Star Market also captured seven of the top 10 A-share listings, including the year’s biggest IPO of Semiconductor Manufacturing International Corporation (SMIC), which raised RMB53 bn ($8.14 bn) through a dual listing in Shanghai and Hong Kong.
The lack of trading limits, combined with the huge demand for new economy companies among investors, means stocks often surge on debut. The average first-day return on the board during 2020 was 187 percent, compared with 44 percent on the main board, according to EY. SMIC did its part to hold up the average, closing its first day 202 percent above the listing price.
Other big IPOs on Star Market last year include Qi An Xin Technology, Cathay Biotech and CanSino Biologics, which each raised more than RMB5 bn.
Star Market also came close to co-hosting the world’s biggest ever market debut. Ant Group had planned to raise $34.4 bn through a dual listing on Star Market and the Stock Exchange of Hong Kong (HKEx), before a high-profile intervention from China’s banking regulator put a halt to proceedings.
The Star Market companies most attractive to investors tend to be small or mid-cap firms that are not listed elsewhere and have a leadership position in a niche area, says Choi. Such a company could, for example, be the leader in drilling equipment for mines. ‘They can quickly increase their market share through product development plus M&A,’ he explains.
The market’s red-hot track record means most companies don’t need to worry about getting investors involved in their IPO, adds Choi. ‘With that 100 percent+ return in front of you, you can hardly refuse,’ he says. ‘Most of the listings are oversubscribed many times.’
Given the huge IPO ‘pops’, don’t companies feel they are leaving money on the table? Choi maintains that this isn’t a concern. First of all, companies are happy they can have much higher multiples than the PE ratio that used to be enforced by the regulator. And second, they know a big price rise will work to their benefit in the form of future share offerings or M&A.
‘As long as they can sell their stock at a high price later, when they have the second round, they are happy enough to have a mismatch at the beginning,’ Choi says.
Paul Lau, partner and head of capital markets at KPMG China, says the type of companies joining Star Market has evolved during its time in operation. ‘At the initial launch of Star Market, listings were mostly small to medium-sized innovative companies with significant importance in research and development,’ he explains. ‘As [time] progressed, there have been a number of industry leaders that have also made successful debuts on Star Market, including SMIC and railroad manufacturing behemoth China Railway Signal & Communication.’
Rules of attraction Another group of companies keen to list on Star Market are ‘red chips’ – Chinese companies incorporated outside China and listed in Hong Kong. Companies have traditionally taken this route to avoid restrictions on foreign investment that affect mainland-incorporated businesses. In May last year CSRC relaxed some requirements to make it easier for them to join a mainland exchange.
To help bring red chips home, China has also developed Chinese depositary receipts (CDRs) – modeled on the American and global versions – which are certificates that represent a certain number of shares. In October scooter maker Segway-Ninebot became the first company to list on Star Market using this new instrument.
This year, Lenovo, the world’s largest computer-maker, became the latest red chip to join Star Market via a CDR. ‘With Lenovo’s strong global presence and heritage in China, we are confident this offering will help further realize Lenovo’s value by leveraging the booming China capital market and at the same time enable investors in China to invest more easily,’ said Yuanqing Yang, Lenovo’s chairman and CEO, in a statement announcing the move.
Lenovo, along with several other Star Market companies, did not respond to a request for comment for this story.
The success of Star Market has led regulators to replicate its approach to IPOs on other trading venues. In April last year CSRC said it would introduce a registration-based IPO system on ChiNext, the growth board of Shenzhen Stock Exchange.
‘Star Market has been used as a testing point for the registration-based system, which is a disclosure-focused approach as adopted by many developed capital markets globally,’ says Lau.
Underlining their appeal, the changes to the ChiNext board caused a big switch in how companies wanted to go public. Of the roughly 200 companies waiting to list, more than 80 percent resubmitted their application using the new process, according to a report by KPMG. Indeed, registration-based IPOs are now the dominant way to list in mainland China: at the end of last year, three quarters of the 800 companies in China’s IPO queue had applied via this system, says EY.
International access While most investors in Star Market are domestic, the level of international involvement is growing. China’s desire to reform its capital markets includes the aim of bringing in more foreign investors, and changes made this year should directly affect the level of overseas ownership on Star Market.
Since February 1, companies listed on the board can be included in the Stock Connect program, which links mainland exchanges with Hong Kong, as long as they meet certain criteria. Previously, overseas investors could trade Star Market securities only if they were registered with China’s Qualified Foreign Institutional Investor program.
Stock Connect offers two investment pathways: the northbound route allows investors to use the HKEx to buy and sell shares listed in Shanghai or Shenzhen. The southbound route sends trades in the opposite direction. The program has proved a popular way for overseas fund managers to access the Chinese mainland.
In November last year Hong Kong and international investors held around RMB2.1 tn in A-shares through the northbound channel, according to data provided by HKEx.
Star Market companies can be included in Stock Connect as long as they are part of either the SSE 180 or the SSE 380 indexes, or if they are also traded in Hong Kong. Under these criteria, 12 companies have initially been included in the program. They include new-economy firms such as Raytron Technology, a developer of infrared imaging technology, and Advanced Micro-Fabrication Equipment, which operates in the semiconductor industry.
The changes will ‘introduce more overseas institutional investors to Star Market and further improve the investor structure and the level of internationalization of China’s capital market,’ says SSE in a statement.
Investment will flow not just from active investment decisions but also from greater exposure to passive funds. Through their addition to Stock Connect, Star Market companies should become eligible for FTSE Russell’s Global Equity Index Series and MSCI products covering A-shares and emerging markets.
This will add to moves already afoot to increase the weighting of Chinese companies in global index products.
‘Chinese A-shares within the MSCI China A Index currently have 20 percent of their total market cap included in broader indexes such as MSCI Emerging Markets,’ explains Brendan Ahern, chief investment officer at Krane Funds Advisors, which launched a Star Market-focused ETF in February. ‘We anticipate MSCI will increase the inclusion factor in the coming years.’
Brendan Ahern, Krane Funds Advisors
The growing links between domestic and overseas equities markets is helping to improve investment research on A-share companies, says Wendy Liu, head of China strategy at UBS Global Research. ‘Since the initial launch of the Stock Connect program, we have seen rising convergence of onshore and offshore markets as offshore investors add A-share exposure and onshore investors add off-shore exposure,’ she says.
‘Onshore investors bring greater due diligence over company fundamentals regarding end-market growth, competitiveness in products and services, quality of management and execution. Global investors bring perspective over business models and global competitive dynamics, valuation and best-in-class standards on corporate governance.’
One factor that remains unclear for Star Market companies is whether new US President Joe Biden will row back some of his predecessor’s moves to put up barriers between US investors and China. In November last year, then-president Donald Trump signed an executive order that banned investment in a list of companies which, in the eyes of Washington, are either owned or controlled by the Chinese military.
The move ultimately led the NYSE to announce the delisting of China Mobile, China Telecom and China Unicom (Hong Kong). Biden is reported to have put on hold the investment ban while he reconsiders Trump’s policies toward China.
‘Senior posts within the Biden administration have been filled by career diplomats who have relationships with their foreign counterparts, unlike the previous administration,’ says Ahern. ‘While the Biden administration will evaluate the previous administration’s policies, it is expected there will be communication and dialogue at a minimum. This could pave the way for a trade and/or investment deal as we saw with China and the EU recently.
‘US-China political rhetoric kept many investors on the sidelines over the last two years, despite China’s strong performance. This underinvestment is apt to be rectified as investors rerate China positions within their portfolios.’
