On Thursday, the Hong Kong stock exchange approved Agricultural Bank of China Ltd.’s application for a $20 billion to $30 billion initial public offering. Hong Kong’s approval now makes the Chinese bank’s IPO a virtual certainty, and the stock could begin trading on both the Hong Kong and Shanghai stock exchanges by mid-July. The deal would represent the world’s largest-ever IPO.
I understand how hungry investors are for picks in China right now, as 2010 has been less than fruitful for the country’s equity markets after a red-hot 2009. The Shanghai Composite Index is down nearly 22% year to date. So investors should rejoice over the opportunity created by the Agricultural Bank of China IPO, right? Wrong.
While the sheer size of Agricultural Bank of China IPO is impressive, the notion that investors in the United States are going to profit mightily is far less than impressive.
First off, there’s the practical question of actually going about buying shares on the Hong Kong and Shanghai exchanges. Yes, it is possible to buy China-listed stocks from most full-service brokerage firms, but they will almost always charge you a very high premium for conducting the transaction. In certain cases, the high cost of buying Hong Kong and/or Shanghai listed securities is worth the price, particularly if you are buying a superb quality company. However as you’ll see, I don’t think the additional cost justifies the purchase in the case of Agricultural Bank of China.
This brings us to the second reason why I’m less-than enthusiastic about this much-hyped deal, and that is the actual quality of the Agricultural Bank of China. The bank is the third-largest lender by assets of the four existing China state-owned banks, and it primarily concentrates on lending to residents in rural parts of the country. Many of these rural residents are peasants and small farmers, a class of Chinese citizen that’s traditionally been much-less financially well off than their urban counterparts.
In fact, some estimates peg China’s average urban resident as having approximately three times as much wealth as the average rural resident. China’s rural population also is much less financially savvy than urban dwellers. This lack of aggregate financial wherewithal, along with limited financial knowledge, means that rural borrowers are much more likely to borrow less and default more often.
The old adage “follow the money” is particularly powerful when assessing a bank’s business model. In the case of Agricultural Bank of China and its rural lending focus, you might say that it’s a bank that’s not following the money — and that’s not a good recipe for solid earnings or strong stock performance.
In preparation for the now-imminent IPO, the Chinese government has spent the past couple of years injecting capital into Agricultural Bank of China to shore up its balance sheet. Considering the company is more than 96%-owned by China’s sovereign-wealth fund and its Ministry of Finance, this task wasn’t too hard to accomplish. And though the bank has been trying to alter its business model somewhat to seek out better-quality borrowers, I expect the company will face some strong headwinds during any proposed transition.
The bottom line here is that I don’t think U.S. investors should be planting seeds in Agricultural Bank of China’s IPO. This deal may be impressive in terms of size, but it’s not an investment likely to harvest much in the way of shareholder profits.