Why you need to pay attention to China’s NASDAQ

 

Great things come from small beginnings.

The NASDAQ stock market is a case in point. It was created in 1971 to increase efficiency and transparency in the over-the-counter (OTC) securities market. These stocks typically did not meet the listing requirements for the New York Stock Exchange (NYSE).

The NASDAQ didn’t have a big building with a trading floor with an open outcry system (where traders and dealers shouted their orders at each other) like the NYSE. It was a purely electronic exchange. And it expanded rapidly.

Today, the NASDAQ is the world’s second-largest stock market, with a total market capitalisation of US$10.8 trillion. It’s home to some of the world’s largest publicly-traded companies, including Apple, Google and Amazon. These three companies alone have a combined market cap of US$2.3 trillion – worth more than the economies of Brazil or Canada.

And we could be about to see the beginnings of a similar exchange in China…

China’s markets have a lot of room for growth

Right now, China has two stock exchanges – one in Shanghai and another in Shenzhen. They’re small compared to their U.S. peers, with a combined market cap of roughly two-thirds of the NASDAQ and approximately one-fourth of the NYSE.

But they have a lot of potential growth.

China is already the world’s largest market for technology. It has the biggest number of internet and mobile phone users of any country in the world. The number of Chinese using social media, online gaming and video streaming is many times larger than the U.S. And China is rapidly transforming into a digital economy, with cashless payments and facial recognition common in most major cities.

Yet, it’s been losing out in the technology IPO market. Many technology companies have chosen to list on the Hong Kong Stock Exchange or the NASDAQ.

Chinese tech firms Tencent Holdings, Alibaba and Baidu – with a combined market cap of over US$800 billion – are all listed outside China. The country’s largest mobile phone manufacturer, Xiaomi, listed its shares in Hong Kong back in July. We also recent wrote (here) about the Spotify of China, Tencent Music, which is looking to list shares on the NASDAQ this month.

China wants a piece of the action

China will be launching its own version of the NASDAQ exchange in Shanghai early next year.

In an effort to attract future tech giants, there will be no profitability requirement for listed companies, compared to the current requirement of a three-year record of profitability. They also plan on adopting a NASDAQ-style IPO filing system that can be done online, making it easier for companies to file their requirements and speed up the approval process (which currently takes up to two years).

The exchange will start accepting IPO applications in March, and plans to start trading the first batch of listed shares in June.

This could be a huge market. According to China Money Network, an artificial intelligence-based platform tracking China’s smart investments and technology innovation, there are now 127 “unicorns” in China. Unicorns are unlisted companies that carry a value of at least US$1 billion.

Moreover, China has 20 unicorns with valuations of at least US$5 billion. The three largest include Ant Financial (US$150 billion), Aliyun (US$67 billion) and Didi Chuxing (US$57 billion).

Ant Financial is Alibaba’s electronic payments business, and now the world’s largest mobile and online payments platform. Aliyun is Alibaba’s cloud computing services business. And Didi Chuxing is the dominant ride-hailing services company in China, which all but kicked out Uber from the market last year.

Getting Chinese companies to re-list

The majority of China’s biggest publicly-traded technology companies are currently listed in the NASDAQ via American Depository Receipts. This puts them out of reach of the average Chinese investor, who’s restricted from investing outside of China as a result of Beijing’s tight capital controls.

But with the new stock exchange in Shanghai, Beijing plans to use the Chinese Depositary Receipts (CDR) system to lure some overseas-listed mainland technology companies to re-list on the local market.

Under the CDR system, a bank acts as a middleman broker between a foreign-listed Chinese company and local Chinese investors. This middleman is known as the depositary bank, holding the shares in a trust, and then offers a new security to the local market.

For instance, Alibaba takes 10 percent of its outstanding U.S.-listed shares and puts them in a trust with the Bank of China. The Bank of China then creates a new security based on these shares, and offers them to local Chinese investors at a price reflective of the U.S.-listed shares’ value.

This will reduce the availability of shares (making them scarcer) on the NASDAQ, and creates a new market for them in China. This will likely lead to sharply higher prices for investors in affected U.S.-listed Chinese stocks.

So it won’t happen overnight, and China’s NASDAQ will surely have a lot of growing pains along the way to becoming a formidable stock exchange. But it’s going to happen. Over time, this exchange could be one of the biggest in the world.

Good investing,

Brian Tycangco
Edtior, Stansberry Pacific Research

 

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