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CSRC loses Xiaomi, but does not lose face

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By John Loh
26 Jun 2018

Xiaomi Corp’s decision last week to drop Chinese Depositary Receipts from its jumbo IPO, following hard questions from the regulator, may look like a backwards step for China. But the regulator was right to put market stability above the whims of any issuer — even if it means turning away the IPO of the year.

The smartphone maker's decision to shelve its up to $5bn CDR sale took markets by surprise last week, especially given the importance of the project to both the issuer and China’s policy makers. Market watchers were quick to say that the move seemed like yet another meddlesome intervention by the China Securities Regulatory Commission (CSRC), and that it does not bode well for other CDR hopefuls.

Under a new plan, Xiaomi will raise $6.1bn with just a Hong Kong IPO, which despite the lack of CDRs will still be the biggest fundraising globally in nearly two years.

The bone of contention appears to be on Xiaomi’s valuations. The world’s fourth-largest smartphone maker has sought to position itself to investors as an internet services company rather than a hardware manufacturer, which would allow it to command premium valuations.

This is despite the fact that smartphone sales make up 70% of Xiaomi’s top line, while its still nascent internet business contributes less than 10%.

Xiaomi’s founder Lei Jun, who fashions himself after Steve Jobs, presented the firm as a cross between Apple and Tencent Holdings during a glitzy weekend pitch to investors in Hong Kong. That argument has been used to justify its price tag of 40 to 51 times estimated 2018 earnings, and 23 to 29 times for 2019 — valuing Xiaomi at relatively twice as expensive as Apple.

But the CSRC sent the issuer a list of 84 questions as part of its CDR listing hearing process, including one that questioned if Xiaomi was truly an internet firm. Was this a step too far for the regulator? Shouldn't the question of how to value companies be left to investors?

Fragile markets

In a perfect world, yes. But the CSRC is tasked with managing a domestic equity market that is often precariously balanced. The country’s mainly retail investor base follows the herd and rarely pays attention to fundamentals. It would be a brave regulator that let these investors fend for themselves.

Markets should be free and investors should drive the narrative, but such an approach falls flat in China where negative events can easily spiral out of control, as the A-share market’s crash in 2015 showed. It was an event that sent even seemingly unconnected global markets into a tailspin.

The memory of that mass investor stampede is probably still fresh in the minds of regulators. The CSRC is doing the smart thing by treading carefully with an asset class that could potentially raise billions, yet for which the rules are not fully ironed out. In the long run, of course, it should be working to bring more institutional investors into the market, ensuring a more sensible approach to valuations.

But in the meantime it cannot ignore the daily reality of markets, which are caught up in a looming trade war between the US and China. Mainland indices have taken the brunt, with the benchmark Shanghai index falling into bear market territory on Tuesday following a $1.8tr rout so far this year.

Xiaomi’s decision to put CDRs on the backburner was not a face-losing event for the CSRC, but a calculated step to preserve market stability. 

By John Loh
26 Jun 2018