The World’s Biggest IPO Market Is Not Healthy

A fast and furious influx of new companies is changing the investing landscape for fund managers in China.

Shuli Ren

18 May 2023, 08:02 AM IST

An IPO sign. (Photographer: Cyril Marcilhacy/Bloomberg)

(Bloomberg Opinion) -- China can claim victory over the US in one area. It is now dominating the global initial public offerings market.

The number of US IPOs has plunged this year, as Wall Street grapples with a regional bank crisis and a debt ceiling standoff in Washington. Meanwhile, companies have secured more than $25 billion across over 100 deals in mainland China year-to-date.

The World’s Biggest IPO Market Is Not Healthy

Businesses sanctioned by the US became market darlings. Hong Kong-listed China Mobile Ltd., for instance, morphed into the country’s most valuable company last month after a 56 billion yuan ($8 billion) offering in Shanghai in late 2021.

In recent years, Beijing has implemented a slew of reforms to make it easier for innovative manufacturers to go public. In 2019, the government launched a new Nasdaq-style tech board in Shanghai, ambitiously calling it the STAR market. Earlier this year, the securities watchdog rolled out a registration-based listing mechanism to all domestic stock exchanges.

At first glance, the outcome is impressive. Since 2019, close to 900 industrial and tech startups have gone public, raising more than $130 billion. Manufacturing firms now account for over half of the mainland’s market cap and for 60% to 70% of its trading volume.

This is a welcome development, especially when the US is escalating its year-long economic campaign, moving from export restrictions to possible investment curbs. China needs a healthy place where startups can raise cash.

On the other hand, the fast and furious influx of new IPOs is also changing the nature of the country’s $10.6 trillion stock market. With so many small and highly specialized firms emerging, asset managers do not have enough resources to do proper due diligence. An equity market that was finally making progress with institutional investors is once again dominated by retail traders.

Among the 1,500-plus firms that have gone public since the launch of the STAR board four years ago, less than 60% have analyst coverage, according to data compiled by Bloomberg. About 70% of mutual fund holdings still reside with the so-called main board, dominated by financials and state-owned enterprises. STAR companies get only about 9% of money managers’ asset allocations.

This opens the door to speculative trades fueled by social media frenzy. Consider CloudWalk Technology Co., which the US blacklisted in late 2021 for being “part of the Chinese military-industrial complex.” In May 2022, the face-recognition technology provider raised 1.7 billion yuan on STAR, with one-third of its IPO shares purchased by state-backed strategic investors including the Shanghai government.

Trading in CloudWalk has been brisk this year, but not because of its surveillance business. The company was hyped as one of the “AI four little dragons,” even though it hardly generates any revenue from this field. Its stock gained 141%, despite a 79% tumble in first-quarter sales.

CloudWalk certainly did its part to fuel the frenzy. On April 26, it announced a private placement plan to raise 3.6 billion yuan — more than twice the amount of its IPO proceeds — that will go toward AI research. On May 8, it said a new AI-based operation will be launched this month, to be used in smart finance and transportation. There is very little sell-side research on this $3.9 billion market-cap company.

In a retail-driven market, a company does not have to use IPO proceeds for their intended purposes. And meme-stock pickers may not even mind, as long as the management talks up the hottest trends.

President Xi Jinping likes to tell his comrades to retain their “original intent” and not forget why the Communist Party was established in the first place, enforcing this mandate with harsh anti-corruption probes. But how many companies that have gone public in recent years are doing what they had promised to do? China’s sizzling IPO market is not exactly healthy.