IPOs Are Back and China's Got 'Em!

You may have noticed that IPOs in China have started up again after a nine month hiatus. The listing of IPOs has both positive and negative implications. On the positive side of the ledger successful IPOs indicate that there is healthy demand for equities. If demand is healthy then there is a better chance for higher prices. The negative to this is that to the extent IPOs are a supply that is created to meet demand, at some point the ratio of supply versus demand will tilt in favor of supply. This was part of the equation that caused the tech bubble and subsequent popping.

This sort of thing has happened before, think energy stocks in the early 1980s when that sector grew to 30% of the S&P 500 only to fall and then languish around 5% of that index for years, and will happen again.

The catalyst for this post is news from last night that one of the latest IPOs in China is a company called BaWang International, a shampoo maker. According to 24/7 Wall Street the offering oversubscribed by 400 times. Perhaps BaWang makes a helluva shampoo but it seems to me that shampoo, or toothpaste for that matter, is not a high growth area. We all use these things but our consumption habits of these items don’t change meaningfully.

Contrast a shampoo company versus a company that addresses something that must be solved. China has problems with pollution, is spending money to modernize the infrastructure and diets are generally improving.

A few days ago Chinese water treatment company Duoyuan Global Water (NYSE: DGW) started trading on the NYSE. It was a very hot issue, it is up 30% from its IPO price. China needs a lot more clean water and DGW cleans water. The pollution problem must be solved and DGW might be a part of the solution.

To be clear, I do not own DGW nor do I know the extent to which it will be part of the solution but it is in a space where money must be spent on a problem that must be solved. US based investors have had ever increasing ways to invest in China and they need to be very selective in how they get into China. I think the best way in is with companies that are one way or another involved with the story on the ground in China of an ascending middle class except banks (I don’t actually think of banks as being part of this but some folks might). I would also want to exclude consumer product companies (like shampoo companies) and exporters.

Obviously consumer stocks, exporters and financials could outperform but I believe the longer term fundamental case for them is weaker.

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