China Inc. Finds Cure to Debt Hangover in Stock-Market Boom
APRIL 27, 2015
China Inc. is turning to the stock market for a cure to its unprecedented debt hangover.
As authorities show a newfound tolerance for defaults and debt levels at Shanghai Composite Index members climb to all- time highs, Chinese companies are increasingly tapping the equity market for funds to pay down liabilities and invest in growth. They’ve announced $82 billion of secondary stock offerings in 2015, a figure UBS Group predicts will increase to a record $161 billion by December. That comes on top of $10 billion already raised through IPOs.
Investor appetite for new shares has rarely been stronger after a world-beating rally in the Shanghai Composite added $4.4 trillion to China’s market capitalization over the past year.
While the gains came too late to stave off the first default on domestic debt by a state-run company last week, officials at both China’s securities regulator and the central bank have endorsed the flow of funds into equities as a way to support an economy growing at the slowest pace since 2009.
“Valuations are very high now thanks to the stock rally and capital is very cheap,” said Xu Gao, the chief economist at China Everbright Securities in Beijing. “Companies that have access to the stock market will be able to tap the cheap funds.”
The Shanghai Composite rose 3 percent on Monday to close at the highest level since February 2008.
Equity fundraising in China surpassed net sales of corporate debt last month for just the third time in the past three years, according to data compiled by Bloomberg.
In one of the latest examples of the shift, China Eastern Airlines Corp. said on April 23 that it plans to sell as much as 15 billion yuan ($2.4 billion) of stock to fund the purchase of 23 planes and pay off debt. Shares rose 10 percent in Shanghai after the news as they resumed trading following a two-week halt.
Shanghai Fosun Pharmaceutical Group, a drugmaker backed by billionaire Guo Guangchang, said April 16 it will raise as much as 5.8 billion yuan from a stock sale and apply more than 60 percent of the proceeds toward repaying debt. Lingyuan Iron & Steel, whose share price has more than doubled in the past 12 months, said in February it will sell as much as 2 billion yuan of shares in a private placement to repay bank loans.
The aggregate debt-to-equity ratio for companies in the Shanghai Composite reached 165 percent in January, the highest level since Bloomberg began compiling the data in 2005.
“This will help some companies improve their debt indicators,” said Liao Qiang, a Beijing-based senior director at Standard & Poor’s.
The risk is that a jump in new share sales overwhelms investor demand after the Shanghai Composite’s valuation increased to the highest level in five years.
Supply surges have triggered the collapse of four of seven Chinese stock-market booms since 1992, UBS analyst Lu Wenjie wrote in a March 27 research report. The Shanghai gauge dropped as much as 2.2 percent on Friday after regulators said they will speed up the pace of IPO approvals.
“We still see a significant downside risk in China’s stock market,” said Mole Hau, an economist at BNP Paribas SA in Hong Kong. “The very high price-to-earnings ratios that we are seeing are not supported by fundamentals.”
The money raised through some stock sales will help boost the world’s second-largest economy as companies invest the proceeds to grow their businesses.
Hainan Airlines, the carrier based on a tropical island in southern China, is seeking 24 billion yuan to buy planes, while China Railway Group is raising as much as 12 billion yuan to fund expressway construction. Chongqing Changan Automobile plans to sell 6 billion yuan of stock to boost production capacity for passenger cars and engines.
Equity financing will play an even bigger role in China after regulators reform the nation’s IPO rules, according to Li Miaoxian, a Beijing-based economist at Bocom International Holdings Co.
Authorities have pledged to move toward a so-called “registration system” where markets, rather than regulators, determine most aspects of an offering, including pricing and timing.
Policy makers have been putting pressure on companies to cap the valuations of IPO shares, leading to smaller cash infusions than investors were willing to commit.
Equity markets can channel funds to companies more efficiently than China’s state-run banks, according to Zhao Yang, the Hong Kong-based chief China economist at Nomura Holdings.
“The market can do a better job than the government in deciding which industries offer better returns,” Zhao said. “Capital will reward the best companies in the market with the highest valuation.”