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Chinese small cap companies financially underserved in Hong Kong
Opportunity for wealth managers seen in firms too small to attract big investment banks
Derrick Hong 5 Jan 2021
Joseph Lang, chief executive officer of DL Securities
Joseph Lang, chief executive officer of DL Securities

While most of Asia’s wealth managers are eyeing the new economy sector, some market-leading Chinese companies in traditional industries that have accumulated substantial wealth offshore but still lack financial services due to their size and market cap can provide these managers with great opportunities.

“We are in a very strange world where there are very good companies with market capitalization of between HK$3 billion and HK$6 billion, which are not large enough to attract the big investment banks to provide adequate services and coverage for them, but they are not penny stocks nor shell companies,” says Joseph Lang, chief executive officer of DL Securities and a DL Holdings partner, in an interview with The Asset. “They are industry leaders, paying out good dividends, but are extremely undervalued compared with their peers, with some of them trading at low single-digit PE [price-to-earning ratio].”

Those companies, Lang notes, do not have much institutional coverage and do not possess a large amount of daily transactional volume. Thus, they are often overlooked by many investment banks and securities firms.

“It is not that they are unable to pay bulge-bracket fees,” Lang points out. “They are willing to, but not many banks care because it does not exceed most of their internal protocols, many of which require a company to have a market capitalization of at least HK$10 billion in order to do business with them.”

To wealth managers, one typical question from clients is what to invest in. For Chinese entrepreneurs who are convinced that their businesses are undervalued, according to Lang, the best investment would be to invest in their own businesses.

“If our client has a company on the Hong Kong Stock Exchange, and it’s on the precipice of soaring to new heights, we would strongly urge them to not bet on another horse, but to double down on themselves because they and their company are likely the most undervalued asset with the highest level of upside,” Lang notes. 

The alternative to acquiring more shares in their own companies is privatizing them. A higher valuation in the A-share market acts as a catalyst for the privatization of Hong Kong-listed Chinese companies and relisting on mainland stock exchanges. From 2010 to 2019, over 60 Hong Kong-listed companies announced their privatization plans. Luoxin Pharmaceuticals, for example, completed its privatization in Hong Kong in 2017 and reverse takeover in Shenzhen in 2020.

“A few years back, if a Chinese company wasn’t trading well in Hong Kong, most of them would privatize and try to re-list back in the mainland A-share market, where the company automatically gets a boost in valuation as well as transactional volume,” Lang explains. “The reasoning behind their decision is pretty easy, mainlanders understand mainland companies much better than an investor pool that is only limited to international investors. On the other hand, the process is tricky and not very easy, nor practical, to do. If the re-listing fails, the cost could be financially devastating.”

The other factor that could boost valuation is a company’s inclusion in the Stock Connect programme, which requires only a minimum market cap for companies. 

“In recent years, due to the innovations of our cross-border financial regulators,” Lang says, “these [smal cap] companies can become a member in the Stock Connect programme, where they can be exposed to both mainland and international investors.”

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