Chinese IPOs Are Hot - Here’s How To Profit On Them

November 20, 2017

Chinese IPOs Are Hot – Here’s How To Profit On Them

  • Today I’ll discuss 3 recent Chinese IPOs and will give you a few investing tips through these examples.
  • One thing you have to be accustomed to is volatility, thus allocate a proper part of your portfolio to Chinese IPOs.



Introduction

Investing in recent IPOs in a treacherous thing to do.

The first difficulty is that there aren’t any historical prices to study. This is somewhat of a good thing because it means we cant anchor to any past stock prices which allows us to really be what investors should be, business analysts.

In today’s article, we’ll dig into a few recent Chinese IPOs to see what’s on the table and what the risks and rewards to such investments are.

The investing community at large may call these IPOs risky because of their unusually high volatility, but proper analysis should enable us to minimize the risks and leave the upside open where there is upside potential.

I’ll start by describing 3 recent IPOs to show you what you can expect by venturing into the murky IPO waters.

Sogou (NYSE: SOGO)

The best way to analyze a new IPO is to look at its prospectus and at its impact in the actual market it is operating in.

SOGO is a Chinese search engine that has just 3% market share, but it’s also the default search engine on the famous Chinese WeChat app and is backed by Tencent which owns a 37% stake in it.

About 36% of SOGO’s traffic comes from Tencent’s platforms and Sogou Search will be offered as the default general search engine to users of Tencent’s products until September 2018 with plans to expand the collaboration up to 2023. Such a dependence on a big player like Tencent is what makes SOGO a risky play.

The company recently raised $585 million in its IPO which made immediately it a $5 billion company.

Figure 1: SOGO’s growth and operations. Source: SOGO’s prospectus.

The second important thing to look at is valuation.

SOGO’s net income was $66 million in the first 9 months of 2017, or $0.15 per share. If we assume a 46% increase in net income for the full year, as has been the case compared to 2016, we get a net income of $96 million which is $0.24 per share for a price to earnings ratio of 54. So a small search engine that is primarily dependent on Tencent has a similar PE ratio as Alibaba.

The third important thing to do is to read the risk section of the prospectus where the investment bank that sponsors the IPO describes the risks. As mentioned above, SOGO’s operations are mostly dependent on Tencent’s will, which makes it a big risk.



Qudian (NYSE: QD)

QD is a Chinese micro-lending specialist that’s dependent on Alibaba’s Alipay platform where buyers and merchants can easily access credit that’s decided on within seconds.

The IPO price was $24 which leads me to another interesting thing about IPOs, the after-IPO volatility.

Figure 2: QD’s stock price since IPO. Source: CNN Money.

With QD, the stock price surged to $35 immediately after the IPO, only to fall to $22 which is below the IPO price. This shows just how much exuberance surrounding an IPO there can be, which is something investors should be keenly aware of.

The $900 million that was invested in QD at the IPO means that the smart money knew the price it would buy at. Retail investors often jump in after the IPO hoping to make a quick profit, but it often ends badly, and certainly did for those who bought QD at $35. Nevertheless, wise investors should wait until the dust settles and analyze what the company actually offers before investing.

What QD offers is staggering growth numbers.

Figure 3: QD’s revenue growth. Source: QD.

 

On the valuation side, QD’s earnings in Q3 2017 were $0.33 per share which would make it $1.32 for the whole year, and give it a PE ratio of just 18 which—when compared to SOGO—shows just how differently IPO stocks can be valued.

ZTO Express (NYSE: ZTO) & Best Inc. (NYSE: BSTI)

ZTO is a Chinese logistics company that went public a year ago at $17 per share. After the IPO, the stock fell to $11 only to recover as the company continued to show growing numbers and profits.

Figure 4: ZTO’s stock price since IPO. Source: CNN Money.

This again shows how you should always be ready for volatility with Chinese IPOs.

I’ll now share a sad fact with you. If you go through an IPO prospectus in detail, you’d be one of only a handful of investors to do so. With IPOs, research can really pay off as there isn’t much market research out there and most investors, even institutional investors, first expect the confirmation of an idea and only then feel confident to invest.

If you read ZTO’s annual report, you’d see that 75% of their revenue is dependent on Alibaba. This is funny because Alibaba owned 27% of another logistics company that just had its IPO, Best Inc. (NYSE: BSTI). If Alibaba switches to promoting BSTI instead of ZTO when customers purchase their goods, it might be a very negative thing for ZTO. Nevertheless, the growth in the Chinese e-commerce market might mitigate that risk for a while.



Conclusion

We’re living in a world that is changing at lightning speed. 30 years ago, Chinese IPOs were something unthinkable and now there are so many of them both in the U.S. and in Hong Kong that it’s difficult to follow all of them. But the immense growth these companies offer makes them must for a well-diversified portfolio.

The main point is that proper research is necessary to find the real gems that can enrich your portfolio. Institutional investors are typically in the same position as retail investors and are careful not to overpay for an IPO. It’s difficult for them to project the extreme growth rates companies like QD have into the future, and therefore, IPOs will always present a lot of opportunity.

But the risks are also huge as most of these companies operate in a niche environment and are often dependent on search engines or a larger partner.

© 2017 Investiv