IPO guidance spurs stock speculation

Chinese regulators' IPO guidance sparked stock speculation as the market saw shares of 10 new listings in the last two weeks double or triple within one week of their debut.

The Chinese securities regulator ended a 14-month IPO freeze in January, promising market-based reforms to revive one of the world's worst-performing stock markets.

Yet in the latest round of IPOs, the new listings again became a feast of rampant speculation by investors who prefer taking a quick profit rather than making a value investment.

Among the newly listed, Shandong Longda Meat Foodstuff Co., Ltd., was suspended from trading on Monday after its shares rose an accumulated 20 percent during three consecutive trading days. It resumed trading on Tuesday and hit the upper limit once again in early morning trade.

Analysts say the straight rise came as a result of window guidance by the China Securities Regulatory Commission (CRSC), the country's top securities regulator.

Prior to their IPOs, the CRSC urged the 10 companies to refrain from over-pricing, over-raising capital, and selling shares currently held by existing stakeholders.

Such guidance, seen by stock underwriters and institutional investors as de-facto interference, suppressed the offering prices of these stocks.

Most of the new listings opened at a price no more than 20 times their 2013 earnings, which is below the average price-to-earning ratios in their respective sectors, suggesting cheaper valuation than their peers.

Besides cheap valuation, institutional investors argued such interference disrupted a relatively market-based price discovery process during off-line share allocation. Institutional investors pitch what they think a soon-to-be public company is worth and the offering price is based on these quotes.

With this administrative limit in place, institutional investors who have participated in these off-line allocations said figuring out the price has become simple math: divide the amount of capital a company wants to raise by the number of shares to be issued and you'll get the offering price.

Regulators also allocated more shares to be subscribed by retail investors this time. This has led to institutional investors scrambling for 10 percent of the shares some of the companies have put up for sale, while the remaining 90 percent are up for grabs for retail investors.

Previously, some institutional investors would borrow to buy new stocks, but in the latest round of IPOs, some institutional investors were allocated as few as 2000 shares, which squeezed out room for institutions to take a profit through leverage.

However, retail investors hold a different view, saying cheap valuation makes these shares more affordable and gives them greater potential to rise once they are traded on the open market.

"This is the first time I have ever snatched up shares in the primary market," said a man surnamed Wang in Shanghai. He was referring to the 1,000 shares he has successfully subscribed for each of two new listings.

A veteran investor since the early 1990s, Wang has been through the thick and thin of China's stock market.

One of his picks, Guangdong Ellington Electronics Technology Co., Ltd., has seen its share price more than double since its debut on the Shanghai stock exchange on July 1. His other pick, Zhejiang Shapuaisi Pharmaceutical Co., Ltd., is also set to double its offering price.

"The stock market has been too bearish for too long. Regulators should do something to mobilize investors," Wang said.

"It's extremely lucky to get these shares," said Ye Xiaohua, another investor who has bought shares of two new listings. "It is a risk-free investment. These shares will rise for sure and even double what they are worth as soon as they begin to trade on the stock exchange."

Shares of the 10 newly listed firms have so far rarely changed hands, indicating that investors are expecting further gains.

As China's stock market is dominated by retail investors, the regulator's move to limit capitalization of new issuance could strike a balance between retail and institutional investors, according to Anthony Wu, a partner with Deloitte.

"If a stock is too pricey, it could just hurt retail investors," Wu said.

CBRC spokesperson Zhang Xiaojun said there is no definite timetable to change the IPO process from the approval-based system to a registration-based one.

The spokesperson cautioned against haste in implementing IPO reforms, saying some crucial steps are to be taken, including revising the securities law.

The latest measure to reform China's capital market came on Friday when the securities regulator announced rules for companies to delist from the stock market.

Deloitte's Wu said regulators should strengthen rules to crack down on accounting fraud and insider trading.

Wu urged regulators to watch out for retail investors' interests. "If regulators fail to take concrete actions on these fronts, then the transition to a registration-based IPO system will be an unfulfilled promise," Wu said.