News of Air China reducing the amount of its domestic initial public offering (IPO) and the securities regulator considering revising IPO rules caused the stock market to surge yesterday after days of sluggishness.

The benchmark Shanghai composite index yesterday rose 2.14 percent to close at 1,580.58 points.

Air China yesterday announced it would issue 1.639 billion A shares at the offer price of 2.80 yuan (35 US cents) per share, cutting the offer by 39 percent from up to 2.7 billion shares after a weak subscription from institutional investors.

Institutional investors had subscribed to a combined 469.5 million shares by Monday, leaving 819.5 million shares remaining, with around 50 percent of the company's total IPO to be sold on-line from today.

Yesterday's market was also encouraged by a possible reform of the rules on setting IPO prices following local media reports. The reports said that the China Securities Regulatory Commission (CSRC) and some leading securities houses held a conference in Northeast China's Harbin to probe problems in the launch of new IPOs since the government lifted its year-long ban on capital-raising in May.

IPO pricing flaws

The market's weak demand for Air China shares somehow exposed flaws in the current IPO pricing rules set by the securities regulator.

Under the current rules, institutional investors can submit a bid for the IPO price without any obligation to buy the shares. Institutional investors usually offered a higher price in the first stage, but only subscribed to a few shares later on.

Analysts noted that Air China's IPO price being too high revealed the flaws of the pricing system.

"The company last week set the price range at between 2.75 yuan (34.4 US cents) and 2.95 yuan (36.9 US cents) per share, but from my view the reasonable price should be between 2.6 yuan (32.5 US cents) to 2.7 yuan (33.8 US cents), considering the bad performance of the airline industry and the relatively excessive supply of new IPOs in the market," said Li Lei, an airline analyst with CITIC China Securities.

"Air China's share price is set too high, especially in a time when a slew of new IPOs have given investors many choices. The securities regulator should consider easing the steps for new IPOs as there have been too many new IPOs in the market in the past months," a chief investment officer with a joint venture fund management company said.

The shares are being offered at a price that is about twice as high, relative to earnings, as its 2004 offer in Hong Kong.

Despite the market rebound, analysts believed Air China would encounter a frosty start to its first trading day in Shanghai, similar to Daqin Railway Co Ltd.

The recently listed company's shares saw an 11.52 percent increase on their IPO debut price much lower than that of the Bank of China, which soared 23.06 percent.

"Air China will not enjoy a warm welcome, because the performance of airline companies has been even worse than that of the rail enterprises," said Wei Daoke, an analyst with Shenyin Wanguo Securities.

Losses at China's 14 airlines widened 23 percent to 430 million yuan (US$53.8 million) in the second quarter because of government restrictions on fare increases, new routes and fuel hedging.

Comparatively, the new blue chip IPOs expected in the following months, such as the Industrial and Commercial Bank of China, China Mobile and PetroChina, are much more attractive than airline shares.

Weakest period ahead

Yesterday's rebound would not, however, boost the market in the third quarter as overall sentiment remains weak, according to analysts.

A slew of new capital-raising activities including IPOs, seasoned offers and the trade of previously locked-up shares will see the supply of new shares exceeding demand.

From August, some listed companies will be able to trade shares that were previously locked up in the securities reform. The combined total of locked-up shares that could be traded on the market is 33.9 billion yuan (US$4.24 billion) in August, 10.4 billion (US$1.3 billion) in October, 14.5 billion (US$1.81 billion) in November and 16.8 billion (US$2.1 billion) in December, according to CITIC Securities estimates.

"It put pressure on the market, especially in August, which saw the largest amount of such shares trading," Wei said.

Anticipation of the government's tightening measures on the fast-growing economy, especially the property market, will also have a negative impact on the market.

The National Development and Reform Commission (NDRC) yesterday reported a new cycle of overheated investment had occurred, with fixed-assets investment worth over 500,000 yuan (US$62,500) exceeding 1 trillion yuan (US$125 billion) for the first time in June, a 33.9 percent rise year-on-year.

The NDRC suggested a series of interest rate rises to cool down the overheated economy.

"I think the third quarter will be the weakest period of the market, but there certainly are some investment opportunities in the second half of the year," Wei said.

Meanwhile, anticipation of a flat financial result overall for listed companies in Shanghai and Shenzhen in the first half of this year will not add much confidence for investors.

Analysts expected that the over 1,000 domestic listed companies would probably see a combined 5 percent loss in the second quarter compared with the same period last year. This is much better than that of the first quarter, which saw a 13.3 percent loss year-on-year.

(China Daily August 9, 2006)