The China Market: Unreal Valuations Revisited

China Economic Quarterly

(This article originally appeared in the September 22, 2003 issue of South China Morning Post in Hong Kong and is reproduced here with permission from the publisher)

Last week, we began plumbing the mystery of the value of China's state-owned assets. Although the government believes them to be worth 11.8 trillion yuan, or 116 per cent of gross domestic product, the true figure is probably much lower.

But how much lower? This is impossible to know, in large measure because of the continuing lack of effective capital markets that can put some sort of realistic value on Chinese companies and assets.

China's stock markets have listed about 1,300 companies, most of which are state-owned enterprises. But despite their name, they are not really markets, because they do not tell us the value of anything.

Chinese companies, broadly, have two types of shares: A-shares, which are freely tradeable on the Shanghai and Shenzhen stock exchanges; and various types of "legal-person" shares owned by state or corporate entities, which may not be traded on the exchanges. (We are ignoring foreign-currency shares traded either on domestic markets or in Hong Kong, since for most Chinese companies, these shares are a negligible part of share capital).

At the end of last year, 35 per cent of the domestic shares issued by Chinese companies were tradeable A-shares. The remaining 65 per cent were non-tradeable shares.

To determine the value of a Chinese listed company, one must know not just the price of its A-shares, which is publicly available, but more importantly, the value of the legal-person shares. These are often called "non-tradeable" because they cannot be traded on the exchanges, but in fact they have often changed hands in recent years in private transactions.

In most such transactions, these shares have been sold at net-asset value, which is the lowest value permitted by Chinese regulations.

Thus, every listed Chinese company has, effectively, two distinct share prices: the public A-share price, and the (usually much lower) net-asset value price, which its non-exchange-tradeable shares would fetch in private transactions.

The discrepancy is huge. If all the shares of all China's listed companies were valued at the public, A-share price, then total market capitalisation at the end of last year would have been US$451 billion - about the same as Australia's share market. If all shares were valued at the private, net-asset value price, then total market value would have been about 70 per cent less - US$142 billion, or about the same size as the Malaysian market.

Which of these values is the "true" value of the market? We have no idea. Is the "true" value somewhere in between? It could be. But then again, maybe not. After all, the net-asset value of these companies is a price set not by a market but by the administration, since it is state-owned valuation agencies that determine the value of assets at state companies. In many cases, there is no question that the value set by agencies is higher than the true market value of the assets.

So, it is also possible that the real value of China's stock market is less than US$142 billion - less, that is, than Malaysia, an economy less than one-twelfth the size of China.