Charles Prince’s visit to China last week came not a moment too soon, just as a largely state-owned Chinese bank made headway toward surpassing Citigroup Inc.
That humiliation briefly befell Bank of America Corp. last week, when its market value was exceeded by Industrial & Commercial Bank of China Ltd, (ICBC) which few investors had probably heard of a year ago.
By the end of Asian trading on 30 March, the Beijing-based bank was back to No. 3 with a stock valuation of $225 billion, compared with Citigroup’s $252 billion and Bank of America’s $229 billion. Yet given the mania surrounding China, how long will it be before Bank of America and then Citigroup are bested by ICBC? Two years? Two months? Sooner?
Of course, it may never happen, especially if investors begin realizing they are essentially buying shares in state-run companies. Even after October’s initial public offering, for example, China’s government owns about 70% of ICBC. Managers tend to serve their biggest shareholder.
Maybe Prince is missing the plot here. Perhaps Citigroup should do a share sale in China. Why not sell shares in an entity called CitiChina Inc.? Or even better: CitiChina.com? That way, he would combine China and the Internet, the global economy’s two biggest sales tools right now.
Like adding “.com” at the end of a company’s name in the late 1990s, China has become an economic equivalent of sex—it sells. If you want media buzz and investors lining up for a prospectus, toss “China” into the name.
All of this is a bit tongue-in-cheek. It’s fun to muse about, but highly unlikely. It still gets at a serious point: The gold-rush mentality over Chinese bank shares may prove even more irrational than the one in US technology stocks in 1999.
Klaus Kaldemorgen, head of Deutsche Bank AG’s DWS mutual fund unit, which manages the equivalent of $338 billion, put it well last month: “I like Chinese companies, but the valuations in the financial sector are just ridiculous and incredibly inflated.”
One wonders if investors should consider China a good place to raise capital at the moment. So-called pyramid schemes usually work out for those who get in early. Those who join later often experience big losses and realize the folly of such an idea—in Asia or elsewhere.
Citigroup is focusing more and more on Asia. Prince may add more than 10,000 employees in the region through acquisitions even though he aims to reduce annual expenses by at least $1 billion.
He plans to buy Bank of Overseas Chinese in Taiwan and Tokyo-based brokerage Nikko Cordial.
It’s a smart move. Citigroup generates only about 20% of its profit from Asia, compared with 41% at London-based HSBC Holdings Plc. Expanding in Asia is a no- brainer at a time when Prince wants more than 60% of earnings to come from outside the US, up from 45% last year.
Even with the many risks to China’s outlook, 10% growth and at least $2 trillion of household savings are forcing international banks such as Citigroup to rush into Asia’s No. 2 economy.
The idea is that if you are going to bet on China’s boom, banks are the place to be.
There’s also a bit of a “Jeffrey Vinik effect” at play. In the 1990s, Vinik managed Fidelity Investments’ flagship Magellan Fund. He grew bearish on technology stocks in 1995 and loaded up on bonds. The bond market soured, technology shares boomed and Vinik resigned in May 1996 as Magellan’s performance plummeted.
The moral of the story: It’s tough to fight the herd mentality that often pervades markets, even if you’re eventually proven right.
Like Warren Buffett, who also eschewed technology investments, Vinik was vindicated when the US bubble imploded in 2000. One wonders if the same will be true of observers wary that Chinese stocks are a disaster waiting to happen.
Bankers don’t have that luxury, though. China’s promise demands their presence there, whatever the future may hold. It’s worth noting, though, that even China’s financial watchdog, auditor-general Li Jinhua, seems to be raising a warning flag for foreign investors who have spent $74 billion on shares in his country’s banks since 2001.
“It would be naive to think that once these state-owned banks are listed publicly they won’t suffer any operational problems,” Li, whose position as the head of China’s National Audit Office gives him cabinet minister status, told Bloomberg News last month. “It might take a whole generation to get these banks into reasonable shape.”
Banks may be a microcosm of China’s broader stock markets. Even after a roughly 260% increase in China’s benchmark CSI 300 Index—formerly known as the Shanghai and Shenzhen 300 Index—in the past year, investors are still piling in. How is that not a bubble?
China is a day-trader’s paradise and things could end badly for a growing number of individual investors. It’s also an IPO wonderland for companies involved in banking and finance, at least at the moment.
The real question is what the future holds for those loading up on Chinese bank shares. The answer may determine whether China thrives or is held back by a weak financial system.
In the meantime, Citigroup’s Prince will have to work harder to keep homegrown Chinese lenders from taking his crown.