24.01.06By Dan Slater
The oft-heard contention that "markets know best" makes me laugh when, as a financial journalist, I am privy to the ingenious methods investment bankers use to manipulate the sharemarkets. With their vast liquidity, armies of analysts, journalists and expert regulators, sharemarkets should represent the quintessence of a market, yet they are so malleable. A Chinese journalist asked me on Sunday what I thought about the reform of Chinese banks, in particular the US$9 billion listing before Christmas of China Construction Bank. I answered that if you didn't believe in China's reform process over the last 20 years, you would not feel you have to buy shares in the banks - but if you did, you couldn't avoid them. I have seen enough of China's changes in the past 10 years to believe that the changes are pretty much irreversible, so I happen to think the banks are a good buy. But that was not initially the case with fund managers when it came to buying China Construction Bank, and the investment bankers in charge reverted to tried-and-trusted means for whipping up the necessary investor sentiment. These techniques are what make me sceptical about the efficiency of the "markets" in pricing the banks correctly. I can see the process that worked so well with CCB swinging into action with Industrial and Commercial Bank of China (ICBC). Goldman Sachs Private Equity, the Allianz Group and American Express said at the weekend that they would spend US$3.8 billion on acquiring a 10 per cent stake in one of China's biggest lenders. To the investment bankers in charge of the IPO, getting a "strategic investor" on board is a big step in reassuring fund managers and retail investors that the banks will come to the sharemarket with a partner who will help them restructure. In practice, a private consortium like the one headed by Goldman is never there for the long term - they are interested in quick money. Still, fund managers and retail investors will take comfort, and that's the main thing. Hong Kong has an interesting dynamic because the retail element is strong. That's a godsend for investment bankers, who can use the retail element to force institutional investors (such as fund managers) to pay more. A few careful leaks to the press can easily trigger a stampede to buy a certain stock in a city as gambling-oriented as Hong Kong. I'm not saying Hong Kong retail investors are stupid. It has always been a place where you bet big to make money on real estate, the horses and the sharemarket. Retail investors play a big role in Hong Kong because (as in many undemocratic countries) they get special perks from the Government. It's infuriating to professional fund managers that if a deal is sufficiently popular, the original 10 per cent retail allocation is bumped up to 50 per cent. A similar trick the bankers use is leveraging super-rich Japanese retail investors to push up demand for the stock. Fund managers will look uneasily at the sizeable Japanese and Hong Kong retail portion and resign themselves to offering a higher price for the shares. But given the allocation on an especially hot deal of 50 per cent of the stock to Hong Kong retail, fund managers are sure to get less than they asked for. That means they will be buying up shares in the post-IPO, or secondary, market. Naturally, that will be at a higher price. That's good for the I-bankers and the listing company, because it represents a vote of confidence in them by the market. But if the share price goes up too much, the issuer may feel he has sold his shares too cheaply. Shares in CCB have put on 40 per cent in just a few months. Chinese sentiment is predictably upset. They are, in any case, excluded from buying shares in their own banks because the listings are abroad. They see foreigners getting what appears to be a bargain. Valuing a Chinese bank might just as well be made by a baboon on an abacus. Nobody has a clue what the banks are worth because they comprise tens of thousands of tough-as-nails bureaucrats who will do anything to keep their jobs. Distorting information to fit the necessary investment criteria is routinely employed. And their sheer size makes property due diligence impossible. The criteria taken so seriously by foreign investors are also pretty random. One of the most important is the Bank of International Settlement's capital-adequacy ratio. One argument that foreign investors will be making to the Chinese is that their capital-adequacy ratio is much lower than the BIS likes (8 per cent), and this should be reflected in a lower price. But the BIS ratio was "invented" by the US banks in the 1970s because they resented the way Japanese and European banks were out-competing them. By forcing them to raise their capital ratio, they reduced the number of loans such banks could make and, hence, their profitability. By all means buy Chinese banks - but just admit you are taking a gamble. * Dan Slater is a journalist based in Beijing.
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