The biggest IPO in the history of the world
Last month saw the debut of the largest initial public offering (IPO) in the history of the world. Industrial and Commercial Bank of China (ICBC) raised nearly $22 billion, a stupendous sum by anyone’s standards. I would never invest in this stock, for a multitude of reasons, not including the fact that for an issue this size, everybody and his Uncle (and Aunties) will be putting their money into it, and that, is diametrically opposite to our investment philosophy, which is basically to be in the stock before, and not at the same time that everyone’s Uncle is buying. Another good reason would be the fact that recently released reports from major global accounting firms highlighted serious structural weaknesses in the Chinese financial system, just months earlier. State banks are inevitably (but not always) a key part of this weakness and the bigger they are, the more carpets there are to sweep things under (and to eventually clean). After years of institutionalized sweeping, I remain skeptical that management have changed their housekeeping styles after just 1-2 years, and I’d put my bottom dollar on the fact that not all the carpets have been aired.
Looking at ICBC’s past history, it transferred around $85 billion in bad loans to the asset management company, received a $15 billion cash injection from the Chinese recapitalization body in 2005 and earlier this year, sold a 5.8 percent stake to a consortium led by Goldman Sachs for $3.7 billion. After this whirlwind housecleaning, its NPL ratio is now closer to 4% as of June (by its own account) compared to 21% at the end of 2004. Having been an Auditor and a banking analyst for more than eight years, I know never to take for face value what a bank says its NPL levels are, especially a state bank, and especially one that is trying to raise US$22bn, which is also why I’m always amazed at how analysts keep pushing Krung Thai Bank (KTB TB) as a top bank pick in Thailand, but that’s another story. Interestingly, little attention has been given to the fact that China has been recapitalizing and transferring NPLs from state banks for years, without significant changes in management or lending processes. Recent news that ICBC was involved in the pension funds scandal should have already set warning bells going. But I guess the market wants to hear what it wants to hear.
Given that China's average annual economic growth has gone up 9.6 percent since 1978 when the country first opened up to the outside world, there’s no wonder there’s still such an affinity to get a piece of the China growth story. Theoretically, what’s good for the economy should extrapolate into what’s good for a bank which has significant exposure to the general economy. In my opinion, there’s too much hope in that theory.
Many experts have debated on the factors that have led to China's economic growth over the past two decades. A combination of accelerated growth of domestic investment resulting from rise in savings deposits, the foreign direct investment boom since the beginning of the 1990s and the rise in efficiency brought about by market-oriented institutional have all played a vital role in accelerating economic growth. Factors for the rise in productivity over the past two decades, such as the transfer of rural labor force and other resources from agriculture to township enterprises and the primary and secondary industries in cities and the rapid development of non-State-owned economy have all been major contributors to the rapid growth. But technological progress has not, as yet, become the main driving force for the elevation of productivity.
Looking at the recent data on investment in human and R&D capital, the key elements for technological progress, we can see that it is but a matter of time for China (and other Asian economies to catch up). Thomas Friedman, in his book “The World is Flat”, notes that the US economy has been on the forefront of technological breakthroughs because it was fueled by a generation of scientists inspired from the ‘Space Race Era’ in the mid 20th century. However, as this generation of scientists are now in their 50’s to 60’s, the next generation may arguable be coming from abroad, including Europeans, and notably Asians.
After 20 years of high-speed development, shortages have been eliminated and the structure of demand is undergoing significant changes. The motive force for the growth of the extensive economy is weakening. Some unresolved structural defects have increasingly become serious obstacles to further growth. At present, economic growth is faced with major challenges to structural readjustment and industrial upgrading. Still, according to economists, they believe that in the next 20 years, China's economy will continue to develop at a real growth rate of over 6 percent, which means by 2020, when China's per-capita GDP reaches the average level of the present medium-income countries, China will bid farewell to poverty. In my opinion, a most ambitious (and highly challenging) target.
However, a straight line growth is unlikely between now and 2020 and there are many potential speed bumps along the way. Although the past is not necessarily a promise of the future performance, as most financial advisors always like to say, it’s a damn good indication (which is why we fund managers are always beating our chest with our past performance data). As such, although long term outlook for China looks rosy, shorter to medium term, those speed bumps could prove quite bumpy.
The Olympic Curse
The market has many ‘past performance checklists’, one of which is the notorious ‘January effect’ (which I have written about in an earlier memoir), and another of which is the ‘Post Olympics Recession’. If we look at past economic and stockmarket performance of countries that have hosted the Olympics, if past precedent is anything to go by, investors should sell ahead or by the date of Olympics. The premises being that given such large investments before Olympics, the inevitable slowdown post Games will cause a recession or slowdown in growth for the economy.
China’s commitments for the Olympics amounts to US$16.2bn, including $1.6bn spending by the Beijing Organising Committee of the Olympic Games (BOCOG) and $14.3bn in related municipal expenditure. That amounts to almost 20% of Beijing’s 2005 GDP, of which 60% of the non BOCOG spending is for projects to reduce pollution and improve the environment. This is almost 70% more than Barcelona 1992’s expenditure (the highest previous expenditure) and 3x more than Seoul’s 1988 Games. However, spending will be equivalent to 1.2% of China’s GDP. Contrast Japan’s spending for the Games, which came to 3.4% of that year’s GDP and Korea, which was officially said to have spent 1.3% of its GDP on the Games but whose unofficial estimates may have been as high as 7.5%.
All in all, Japan’s economy in 1964 was a culmination of not only the Olympics, but also the IMF and World Bank meeting, the joining of the OECD, the achievement of currency convertibility and the opening of the first ever bullet train. Private consumption has never been as high as it was in 1964. On the other hand, although Korea did not have the culmination of these events, tourism surged by 25% following its 1988 Olympics games, a benefit that Tokyo did not have. Still, at around 1.7% of its GDP, tourism for Korea still only had minimal influence. With tourism revenues currently contributing less than 1% of GDP for China, the impact may be even more insignificant for China whilst the impact on sentiments could be much more substantial. We can’t help but feel there will be some mild hangover post Games, especially for Beijing-nites.
To summarise, there’s no doubt in my mind that China’s growth potential remains enormous and that China will become the next growth engine for non China Asian growth. Despite the recent spike in commodities prices driven by demand from China, this is only the tip of the iceberg, especially when you compare the level of usage or demand relative to the size of the population, for any of the key commodities required for growth and development of the economy. The key question is not whether this growth is sustainable but a question of how to manage this growth going forward. The sexiness of the story has pushed valuations for most ‘China Plays’ towards the high end, and consequently beyond our fund’s ‘reach’. Still, that does not stop us from looking but we are more focused on companies listed in Singapore and Hong Kong that will benefit from either using China as a manufacturing base (old news) or more interestingly, as a supplier to fuel China’s insatiable demand. It’s just better value, in my opinion, and my Uncle doesn’t hold it yet.
Looking at ICBC’s past history, it transferred around $85 billion in bad loans to the asset management company, received a $15 billion cash injection from the Chinese recapitalization body in 2005 and earlier this year, sold a 5.8 percent stake to a consortium led by Goldman Sachs for $3.7 billion. After this whirlwind housecleaning, its NPL ratio is now closer to 4% as of June (by its own account) compared to 21% at the end of 2004. Having been an Auditor and a banking analyst for more than eight years, I know never to take for face value what a bank says its NPL levels are, especially a state bank, and especially one that is trying to raise US$22bn, which is also why I’m always amazed at how analysts keep pushing Krung Thai Bank (KTB TB) as a top bank pick in Thailand, but that’s another story. Interestingly, little attention has been given to the fact that China has been recapitalizing and transferring NPLs from state banks for years, without significant changes in management or lending processes. Recent news that ICBC was involved in the pension funds scandal should have already set warning bells going. But I guess the market wants to hear what it wants to hear.
Given that China's average annual economic growth has gone up 9.6 percent since 1978 when the country first opened up to the outside world, there’s no wonder there’s still such an affinity to get a piece of the China growth story. Theoretically, what’s good for the economy should extrapolate into what’s good for a bank which has significant exposure to the general economy. In my opinion, there’s too much hope in that theory.
Many experts have debated on the factors that have led to China's economic growth over the past two decades. A combination of accelerated growth of domestic investment resulting from rise in savings deposits, the foreign direct investment boom since the beginning of the 1990s and the rise in efficiency brought about by market-oriented institutional have all played a vital role in accelerating economic growth. Factors for the rise in productivity over the past two decades, such as the transfer of rural labor force and other resources from agriculture to township enterprises and the primary and secondary industries in cities and the rapid development of non-State-owned economy have all been major contributors to the rapid growth. But technological progress has not, as yet, become the main driving force for the elevation of productivity.
Looking at the recent data on investment in human and R&D capital, the key elements for technological progress, we can see that it is but a matter of time for China (and other Asian economies to catch up). Thomas Friedman, in his book “The World is Flat”, notes that the US economy has been on the forefront of technological breakthroughs because it was fueled by a generation of scientists inspired from the ‘Space Race Era’ in the mid 20th century. However, as this generation of scientists are now in their 50’s to 60’s, the next generation may arguable be coming from abroad, including Europeans, and notably Asians.
After 20 years of high-speed development, shortages have been eliminated and the structure of demand is undergoing significant changes. The motive force for the growth of the extensive economy is weakening. Some unresolved structural defects have increasingly become serious obstacles to further growth. At present, economic growth is faced with major challenges to structural readjustment and industrial upgrading. Still, according to economists, they believe that in the next 20 years, China's economy will continue to develop at a real growth rate of over 6 percent, which means by 2020, when China's per-capita GDP reaches the average level of the present medium-income countries, China will bid farewell to poverty. In my opinion, a most ambitious (and highly challenging) target.
However, a straight line growth is unlikely between now and 2020 and there are many potential speed bumps along the way. Although the past is not necessarily a promise of the future performance, as most financial advisors always like to say, it’s a damn good indication (which is why we fund managers are always beating our chest with our past performance data). As such, although long term outlook for China looks rosy, shorter to medium term, those speed bumps could prove quite bumpy.
The Olympic Curse
The market has many ‘past performance checklists’, one of which is the notorious ‘January effect’ (which I have written about in an earlier memoir), and another of which is the ‘Post Olympics Recession’. If we look at past economic and stockmarket performance of countries that have hosted the Olympics, if past precedent is anything to go by, investors should sell ahead or by the date of Olympics. The premises being that given such large investments before Olympics, the inevitable slowdown post Games will cause a recession or slowdown in growth for the economy.
China’s commitments for the Olympics amounts to US$16.2bn, including $1.6bn spending by the Beijing Organising Committee of the Olympic Games (BOCOG) and $14.3bn in related municipal expenditure. That amounts to almost 20% of Beijing’s 2005 GDP, of which 60% of the non BOCOG spending is for projects to reduce pollution and improve the environment. This is almost 70% more than Barcelona 1992’s expenditure (the highest previous expenditure) and 3x more than Seoul’s 1988 Games. However, spending will be equivalent to 1.2% of China’s GDP. Contrast Japan’s spending for the Games, which came to 3.4% of that year’s GDP and Korea, which was officially said to have spent 1.3% of its GDP on the Games but whose unofficial estimates may have been as high as 7.5%.
All in all, Japan’s economy in 1964 was a culmination of not only the Olympics, but also the IMF and World Bank meeting, the joining of the OECD, the achievement of currency convertibility and the opening of the first ever bullet train. Private consumption has never been as high as it was in 1964. On the other hand, although Korea did not have the culmination of these events, tourism surged by 25% following its 1988 Olympics games, a benefit that Tokyo did not have. Still, at around 1.7% of its GDP, tourism for Korea still only had minimal influence. With tourism revenues currently contributing less than 1% of GDP for China, the impact may be even more insignificant for China whilst the impact on sentiments could be much more substantial. We can’t help but feel there will be some mild hangover post Games, especially for Beijing-nites.
To summarise, there’s no doubt in my mind that China’s growth potential remains enormous and that China will become the next growth engine for non China Asian growth. Despite the recent spike in commodities prices driven by demand from China, this is only the tip of the iceberg, especially when you compare the level of usage or demand relative to the size of the population, for any of the key commodities required for growth and development of the economy. The key question is not whether this growth is sustainable but a question of how to manage this growth going forward. The sexiness of the story has pushed valuations for most ‘China Plays’ towards the high end, and consequently beyond our fund’s ‘reach’. Still, that does not stop us from looking but we are more focused on companies listed in Singapore and Hong Kong that will benefit from either using China as a manufacturing base (old news) or more interestingly, as a supplier to fuel China’s insatiable demand. It’s just better value, in my opinion, and my Uncle doesn’t hold it yet.
posted by Kenneth | 3:48 PM
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