Drowning their sorrows

Debacle over Chongqing Brewery's failed vaccine rattles fund managers

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13 Jan 2012
Week in China

"That calls for a Carlsberg" is a marketing tagline currently doing the rounds at the Danish brewing giant.

But news from one of Carlsberg's major investments in Chongqing over the last month might have Copenhagen-based bosses calling for something a little stronger.

This follows days of catastrophic trading in the stock of Chongqing Brewery, with the company's share price crashing by more than two-thirds.

Carlsberg has since assured investors that it has "full confidence" in the brewery management in Chongqing, where it has been the largest investor since upping its stake by $379 million in June 2010.

But a group of very annoyed institutional investors in China begs to differ. One fund – Dacheng Fund Management – says it will push for the dismissal of the Chongqing brewer's chairman Huang Minggui at a shareholder meeting on February 7.

"Chongqing Brewery did a bad job disclosing information and it did nothing to cope with the (share price) crisis, which has severely harmed our investors' interests," a Dacheng spokesperson insisted.

What's the background to the share price collapse?

Back in October 1998, Chongqing Brewery spent Rmb14.4 million on a 52% stake in Jiachen Bio-Engineering, also from the Chongqing municipality. Jiachen then began clinical research on a hepatitis B vaccine, and enthusiastic news flow on the prospects for the drug saw the brewer's share price more than double. The stock then went into overdrive after June 2005, when approvals were received from the State Food and Drug Administration to begin the second stages of research. It kept on rising: last year alone it was up almost 50% to peak a little above Rmb83 (a stellar return in a lacklustre year for Chinese markets).

"Chongqing Brewery did a bad job disclosing information and it did nothing to cope with the (share price) crisis...

In fact, optimism for the vaccine remained pretty much unbridled until the very last moment. Financial magazine Capital Week points out that the stock was up more than 18% in the final two days before trading was suspended, in preparation for a much-anticipated statement on the clinical trials in December.

What then followed was a huge shock for investors. On December 7, the Shanghai-listed company revealed that, after more than 12 years of work to produce the vaccine, the clinical trials had not been a success. Chongqing Brewery's share price plunged by the 10% daily limit for nine subsequent trading days, descending to Rmb28.45 by December 22.

Further trading was then suspended until Tuesday this week. But the hiatus was to little avail: the stock was again withdrawn within a couple of hours, after triggering the 10% decline rule.

And now the recriminations?

Larger institutional investors have been making the most noise, especially Dacheng, which owned Chongqing Brewery stock for nine of its fund products.

Of course, a drug vaccine project sounds like an unlikely investment for a brewery to make, although Enid Tsui, writing on the FT Alphaville blog, points out that the vaccines are yeast-based, so at least offer a little common ground.

Similarly, Hepatitis B is a major problem in China. Various studies suggest that a tenth of the population is infected – so if a vaccine could be developed, it would have tremendous commercial potential.

Any hope of that looks like being dashed in Chongqing, as the brewery's research programme will "almost certainly end in failure," reports the Global Times.

Unsurprisingly, this is going down badly with owners of the stock, who feel that they have been blindsided by management, with no indication that the trial's process was so close to collapse.

Worse, there are suspicions that a few insiders may have got wind of the bad news in advance. Caixin magazine has suggested that several institutional investors cashed out close to the peak price per share, and reports too that the China Securities Regulatory Commission (CSRC) has said it will "consider investigating" the case.

Soon afterwards, one of the brewer's directors admitted to selling company stock shortly before the release of the trial results. But according to eastmoney.com, he also insisted that this was only to rectify earlier share purchases made erroneously by his wife.

The wider impact?

It wasn't just Dacheng who was hit, says 21CN Business Herald, which has identified 20 of the largest funds holding Chongqing Brewery's shares.

To get more investment in company bonds and stocks, investors will need convincing that their funds are professionally managed.

In fact, there are media reports that the brewery's slide has triggered fund redemptions of at least Rmb14 billion ($2.2 billion) so far, with the collapsing price creating a scramble among portfolio managers to sell other stocks to meet redemption calls from jittery clients.

Dacheng was again at forefront, according to 21CN, with companies including Laibao Hi-Tech, Aisino and Kangmei Pharmaceutical all suffering weighty declines from the domino-selling effect as it sought to raise cash. The Securities Times agrees that the case has wider ramifications and could force a rethink among investment managers, especially those who have been too concentrated in riskier shares in an effort to chase above market returns.

There has also been criticism that the higher risk projects that fuelled the run up in Chongqing Brewery's price are better suited to specialised private equity outfits than supposedly more cautious mutual fund providers.

Should industry professionals have continued buying into a company that was trading at a price-to-earnings multiple of 108 times – more than a little speculative compared with Chongqing Brewery's peer group?

Bigger picture: difficult times for fund managers...

Putting aside some of the challenges of corporate governance for asset managers, another key concern has been the poor performance of the A-share market, which hasn't provided much of an environment for fund firms to grow and prosper.

This isn't just about rocky global market conditions – fund managers gripe that IPOs have flowed on a feast-or-famine basis, and that there has been further downward pressure on stocks thanks to state-owned firms' releasing their erstwhile non-tradable shares onto the market. Companies and business owners may have done well, but investors have suffered.

As a result the fund management industry remains in a state of arrested development, with the latest data (from KPMG, for 2010) showing a ratio of mutual funds under management to bank deposits at 3.3%, compared to 143.4% in the US.

Since reaching a peak in 2007, assets under management have also been shrinking, and they were down by a further 12% to Rmb2.19 trillion last year. Long-only funds have been overtaken by trust firms and bank wealth management divisions, which have been yielding higher returns.

This is a problem for policymakers, who would like to encourage savers to consider a more conservative range of investment options (better the selection of a blue-chip fund than punting your cash on a third apartment in Erdos, or a flutter on a warehouse full of garlic in Jilin, for instance).


HSBC anticipates renewed focus on the 'dismal' performance of Chinese stocks.

But to get more investment in company bonds and stocks, investors will need convincing that their funds are professionally managed and capable of generating reliable returns.

Hence asset managers will be hoping stocks will get a boost from the latest meeting of the five-yearly Financial Work Conference, which convened last week. That's because the conference – the subject of a research note from HSBC's equity strategy team – has previously been influential, with China's equity markets rising strongly (by 15-20%) after three earlier meetings.

Each proved to be more than talking shops: the 1997 gathering saw announcements of a wave of banking reform; 2002 welcomed a new banking regulator as a separate body to the People's Bank of China, as well as the creation of the Central Huijin Investment Company (see WiC62); and in 2007 the formation of China Investment Corporation was announced, as well measures designed to boost the corporate bond market.

And this time around?

HSBC wonders if the latest meeting could also turn out to be a "potential game-changer" in the longer run (especially in conjunction with changes made at the top of the three leading regulatory agencies last year – see WiC128 – and signs of monetary policy heading in a pro-growth direction, see WiC133). Admittedly, this is a more positive response than most of the international media, which was disappointed at the lack of concrete measures announced.

But HSBC anticipates renewed focus on the "dismal" performance of Chinese stocks. According to Steven Sun, HSBC's Head of China Equity Strategy, the A-share market has neither rewarded investors with capital appreciation or dividend income. For example, in the period between 2006 and 2010 he notes that A-share stocks paid Rmb1.7 trillion in dividends but also raised Rmb2.8 trillion in new capital. Sun says that amounted to a "liquidity drain" of over Rmb1 trillion from investors' pockets.

"With new regulations in place this could change," predicts Sun.

One specific measure getting further discussion is the creation of a new body to support short-selling. The new Centralised Securities Lending Exchange will make shares available to qualified fund managers, says the Financial Times, with shares sourced from banks, insurers and fund management firms. That sounds promising. It will allow for hedging, as well as offering more of a chance to earn returns when markets are under-performing. It is also strongly rumoured to have the backing of the new head of the securities regulator, the CSRC.

Meanwhile, Sun expects some respite for weary local fund managers: he forecasts Shanghai's composite index will rise 25% this year. That will be especially welcome news for those licking their wounds from the vaccine debacle.

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