‘Red Chips’ Put Heat in Hong Kong Market

HONG KONG —  Ask C.Y. Liu what it is about Beijing Enterprises Holding Ltd. that made him wait in a snaking line three separate times to apply for stock in the new company, and he offers the reasoning that has made many small-time investors here rich.

“I don’t know anything about it,” he says, checking his pager’s tiny screen for the latest stock report. “But the price is going to double, maybe triple.”

Perhaps it is better that he doesn’t know the details about Hong Kong’s hottest stock--a 3-month-old company with no track record and a jumble of businesses, run by the Beijing municipal government and managed by Chinese bureaucrats.

And as the July 1 date draws near for the hand-over of the colony to Chinese control, Hong Kong is going crazy for it.

Beijing Enterprises is the latest “red chip”--a sort of communist blue chip--to list on the stock market here. Red chips are Hong Kong shell companies stuffed with mainland China assets.

Investors see them as a chance to ride China’s 10% growth, with less of the risk of direct investment and more of the rewards of direct connections with high-ranking Chinese leaders. The China-backed companies listed on Hong Kong’s stock exchange have outperformed the territory’s traditional blue chips this year, sometimes dramatically.

The success of the red chips is viewed by many as a vote of confidence in Hong Kong’s impending hand-over--a celebration of the confluence of China’s version of communism and Hong Kong’s free-wheeling capitalism. More and more red chips are on their way to the territory--about 35 more have received China’s approval to be listed here.

Beijing Enterprises is the latest record-breaker. By the close of its initial offer May 23, would-be investors had coughed up $27 billion to bid for shares, more than 1,000 times the value of the stock on offer. A lottery will determine who gets stock and who gets a refund.

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Those who get shares seem sure to make a fast profit. Even before official trading started Thursday, the “gray market” price had tripled, from the official opening of $1.62 to $4.80 a share. When it began to trade on the Hong Kong exchange, it opened at about $5.20.

Beijing Enterprises has better basic assets than many, including a 50% stake in McDonald’s restaurants in Beijing, a brewery and exclusive ticketing rights to the Great Wall. But the fervor for its shares reflects the value of its greatest asset as Hong Kong prepares to integrate with China: mainland connections.

“With the transfer of power comes a redistribution of wealth and influence,” says Chong Leong, a China analyst at ING Barings Securities. “ ‘Red chips’ are seen as a beneficiary of that power.” With Beijing’s backing in a time when the Chinese government wants to show confidence in the impending hand-over, Beijing Enterprises is everyone’s favorite.

What makes the connections matter is the expectation--fulfilled in previous red-chip offerings--that the Chinese will “inject” more assets into the new company, at a price below their worth.

The idea is to boost the share price of the newly listed company and help China’s state get rid of some of its many corporate assets. The chief beneficiaries are the new stockholders and Chinese managers who arrange the transactions, because they usually have stock options themselves.

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With the widely understood but generally tacit promise of discounted assets flowing into the public company, the earnings projections of red chips like Beijing Enterprises often look more modest than they are.

That means there is considerable hidden value in the new shares.

Whether red chips are good long-term plays, though, depends on the quality of the injected assets, says analyst Leong.

“It’s easy to end up with a convoluted company with a bunch of empty assets,” he says, noting that Beijing Enterprises is one of the more solid entries on the exchange. “A third will fail.”

The flood of would-be share subscriptions is so large that it drives up overnight lending rates among banks, which have to come up with the cash investors need to bid on shares.

Beijing Enterprises itself will be able to hold on to the money it raises for five days, long enough to make more than $20 million just on the interest it earns while the company decides who will get stock--or half its forecast profit from normal operations this year.

But the free-money party may soon be over. Officials from Hong Kong’s Stock Exchange and Securities and Futures Commission have warned about “recent unusual prices and volume movements . . . which appear to have no relation to the assets, profitability or prospects of the companies concerned.”

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Red Chips Rising

So-called red---chip stocks--Hong Kong shell companies consisting of mainland China assets--are outperforming the colony’s stock market as investors scramble to get in on China’s rapid growth. Weekly closes and latest:

Red--chip index

Friday: 285.97 +50.0% since April 4

Hang Seng index (in 1,000s)

Friday: 14,757.81 +21.0% since April 4

Source: Bloomberg News