The Science and Technology Innovation Board (STIB) has successfully captured the public’s attention soon after President Xi’s mention at China’s first International Import Expo in Shanghai.
EqualOcean strongly believes that there are strategical significances behind STIB. In this report, an overview of China’s stock market and background information about STIB will be provided followed by features and mechanisms of STIB and companies that EqualOcean believes will benefit the most from STIB.
EqualOcean highlights the following six sectors: AI, cloud computing, integrated circuits, biomedicine, electronic vehicles and intelligent manufacturing as expected key focuses of STIB. From each industry, companies from our EO 500 list that might seek STIB IPO will be covered.
While we cannot predict what will exactly happen after STIB, this report may serve as useful insights to contemplate the hidden reasons behind the design of SITB and its impacts on industries and individual companies.
Overview of the Chinese Stock Markets
The Chinese stock market can be described as volatile and speculative. However, possible reasons why companies decided to seek an IPO overseas are its strict listing rules and slow process.
Since the creation of its stock markets in 1990, China has seen exceptional growth with tremendous returns and high volatility. Over the last decade, Chinese stock markets have often been described as a casino with a lot of speculation and high volatility.
In 2002, China has made some progress in making it's market more easily accessible to foreign investors by introducing a Qualified Foreign Institutional Investor (QFII) Scheme.
Yet, the Chinese stock market is not globalized enough. According to McKinsey, a consultancy, foreign ownership the Chinese stock market is less than 3 percent, compared to 22 percent in the United States and 32 percent in Japan.
The Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) are stock exchanges in China. Generally, old- economy companies tend to seek listings in SSE, whereas new-economy companies embracing trends tend to prefer SZSE.
Currently, the systems used in the Chinese IPO market on both bourses are approval based. The approval-based system was initially aiming at providing better investor protection and ensuring only qualified stocks are listed. However, in recent years the system has been criticized for its low efficiency, distorting the IPO market, and encouraging potential official corruption.
Therefore, there was a need to reform in order to develop a fairer and more transparent listing process. First is the registration system. The registration system was first mentioned in 2013; however, due to various reasons, it was not applied. On March 2, 2019, the final rules confirmed that the registration system will be adopted in STIB.
A comparison between the approval-based and registration system:
Features and mechanisms of STIB
STIB will experiment with the registration system, which features less government intervention and a faster approval process. An example of the registration system is Nasdaq.
Here are some breakthroughs have been made:
#1 Acceptance of VIE, red-chip arrangements and dual structures
A Variable-Interest Entity (VIE) structure and red-chip arrangement are usually adopted by Chinese companies who wish to seek flotation overseas. After several rounds of funding, the dual structure will allow owners to remain their controls.
Many Chinese unicorns are under these structures such as Alibaba and Xiaomi. Thus, using VIE may be an attractive way to get unicorns to return to the home market.
#2 Less regulatory intervention
The Registration System aims to provide the market more choices over which companies get listed and their valuations. Supervision or interventions by authorities will still exist but the absolute authority will be challenged.
# 3 Less strict listing requirements
Companies that are not yet profitable can be listed.
The followings are some quantitative standards:
Valuation above CNY 1 billion. Being profitable for two consecutive years. Net profit is greater than CNY 50 million (after non-recurring losses);
Valuation above CNY 1 billion. Being profitable in the previous year with revenue no less than CNY 100 million
Valuation above CNY 1.5 billion. Revenue in the previous year is no less than CNY 200 million. R&D% is more than 10% of the total revenue.
Valuation above CNY 2 billion. Revenue in the previous year is no less than CNY 300 million. Amount of cash transactions in the past three years is more than CNY 100 million.
Valuation above CNY 3 billion. Revenue in the previous year is no less than CNY 300 million.
There is actually another more flexible standard stating that the valuation of the company is above CNY 3 billion and its key products or markets have great potentials, or received from certain approvals from the government, or invested by leading institutional investors, received approval the stage 2 experiment (for med companies), or have certain technological advantages.
In addition, the max IPO price is smaller or equal to 23 times its projected earnings. This limit indicates that most listings on China’s stock exchanges will not be applied to STIB. This aims at attracting more venture capital or private equity backed unicorn companies.
#4 More fluctuation accepted
Previously, the maximum daily limit for any stock was 10 percent and now it has doubled for STIB to 20%. Moreover, no rise or fall limits will be set within the first 5 days after the company’s IPO.
# 5 Stricter rules on delisting
In the approval bases system, it was arguably harder for companies to get delisted. Tougher rules will be applied to the delisting system of STIB in order to prompt the efficient allocation of resources and market integrity.
What has not yet happened
Day trading is still banned
Previously, one widespread rumor was that the new board will adopt day trading which will allow buying and selling on the same day.
Minimum investment amount
Investors still need to spend at least RMB 500,000 in their trading accounts and have a minimum of 24 months of trading experience. Many previously guessed that the threshold will be lowered in order to encourage market participation.
Sectors & Companies
EqualOcean believes the following industries will benefit the most from STIB. Among this industry, companies among EO500 list will be pointed out.
AI (Artificial intelligence)
Definition: AI is essentially a technology empowers a computer program to learn and to think.
Market Size: The China Academy of Information and Communications Technology (CAICT) reports the market for AI in China has reached CNY 23 billion in 2017 with a YoY growth of 67%. It is expected that the growth rate in 2018 will be of 75%. For now, AI in China is still at the beginning stage.
According to EO Intelligence, ending the second quarter of 2018, there are 922 AI companies.
Importance: AI is expected to have a transformative effect on various industries such as banking, retail, education and so on.
EqualOcean has included the followings in our portfolio
Definition: In the broad definition, cloud computing is providing computing services such as servers, storage, databases, networking, software, analytics, intelligence and more over the Internet.
Basically, there are 3 types of cloud serves which are IaaS, PaaS, and SaaS.
Market Size: Forward Intelligence, a special market research institute, predicts the market size of China’s cloud computing industry will reach USD 103.6 billion (CNY 686.6 billion).
Globally, Alibaba Cloud is the only Chinese company ranked among the top 5 Cloud provider. According to Gartner, AWS and Azure account for 54% and 8% of the total cloud computing market share, while Alibaba Cloud, the third-ranked vendor, only accounts for 3.7% of the total market share.
Importance: According to Microsoft, the top benefits of cloud computing can be lower in costs and improvements in speed, scale, productivity, performance, and arguably security.
The Chinese government has the ambition to fully digitize the country and make the government run in a more transparent and efficient way, thus cloud computing receives a great number of regulatory supports. For example, China’s 12th and 13th Five-Year Plans stated the development of the cloud industry is a major strategic priority for the central government.
Ending November 2018, there are more than 20 provinces have launched policies accelerating companies moving to the cloud.
Alibaba Cloud and UCloud are the EO 500 companies in this sector.
Definition: The integrated circuit, better known as the semiconductor chips. Innovative products are attributed to innovation in semiconductors. And it is complicated to design and produce.
Market Size: According to IC Insights, a market research firm, integrated circuit production in China is projected to nearly double between 2018 and 2023, increasing from USD 23.8 billion to USD 47 billion
China has been the largest consumer of ICs since 2005 albeit with a heavy reliance on imports. According to EE Times, China will invest more than USD 160 million over 10 years to boost its domestic semiconductor production
Importance: Integrated circuits are the fundamental technology to power products from smartphones to cars and spacecraft. In order to achieve technological advances, it requires China to develop its own core technologies. If China successfully becomes a major player in integrated circuits design and manufacturing, other players will face significant challenges.
EqualOcean highlights Horizon Robotics, Cambricon Technologies, and Huawei Haisi (chip division).
Definition: Biomedicine uses drugs, radiation, or surgery to treat symptoms and diseases, which is also known as mainstream medicine, orthodox medicine, and Western medicine.
Market Size: According to Qianzhan Research, the market size for biomedicine in China reached CNY 342 billion in 2017 with a YoY growth of 3.58%.
Biomedical companies feature a large amount of R&D (10%-20% of the total revenue) and a long period of time to develop a new medicine. Thus, EqualOcean believes that biomedical companies with wealthy backers might have a bright future and have more chances to be listed.
Importance: Biomedicine could possibly contribute to improvements in national health. While President Xi prioritized peoples health revealing the direction of the country's health and biomedical development.
United Imaging Healthcare is among our watchlist.
Electric Vehicles (EV)
Definition: Broadly speaking, EV is the type of car that runs at least partially on electricity.
Market Size: China the largest and the fastest growing market for EVs. The sales of EVs reached 1,256 thousand in 2018, increasing from 777 thousand last year.
Importance: Developing EVs could significantly alleviate the domestic population and align with the strategy at the national level to become a leader in terms of technologies.
Chehejia, XPENG Motors, and WM Motor have the potential to get on STIB.
Definition: Intelligent manufacturing is an innovative way to connect and combine people, processes, and machines to have a positive impact on the overall economics of manufacturing
Market Size: According to EO Intelligence, China is still at the beginning stage of the field as only 16% of the total number of China companies started intelligent manufacturing.
Importance: This is part of the Made in China 2025 Plan which aims to transform the traditional manufacturing industry,
EqualOcean believes that for intelligent manufacturing to succeed in China, companies need to develop their own core technology which will not easily be copied by competitors.
EqualOcean has followed QKM Technology.
Surely STIB will come with certain 'Chinese Characteristics', however, regardless STIB will be the China' Nasdaq or a registration system with 'Chinese Characteristics' will not deny itself as a critical move made to reform the current financial market in China.
And we can see that with the introduction of STIB, SSE might be a competitor to Hong Kong Exchanges (HKEX) or even The New York Stock Exchange (NYSE) in the future. In order to better compete the two mentioned above exchanges, increase the number, the amount raised, and quality of IPO are critically important.
As this article mentioned earlier that STIB will make the overall listing process easier, faster, more transparent, less regulatory intervention. That means more IPOs could possibly be made at a faster speed in a more transparent manner. However, the overall financial system in China is not mature enough, the negative consequences might happen due to the reduced regulatory intervention should also be noticed.
Since greater inclusion and support will be given to the high-tech and innovative companies to get listed and finance. This will also optimize the current sector distribution (by market cap) by giving more weights to high-tech sector, and therefore improving the overall quality of the listed companies.
Here is a comparison between the current top 10 listed companies in SSE and SSE, measured by market cap
From the comparison, it can be easily seen that SSE is way lag behind in terms of attracting new economy unicorns. And it must be changed.