Small is Beautiful

Author Name: 
Shenzhen Stock Exchange

Large state-owned companies used to dominate the IPO market in China. Now the tide seems to have changed in favor of small and medium-sized enterprises (SMEs)1].   In the first 10 months of this year, Shenzhen Stock Exchange (SZSE) admitted 261 IPOs, all of which are SMEs. They raised a total of US$36 billion in IPO proceeds. Furthermore, over 400 SMEs are in the pipeline waiting for approval of their prospectuses. 

The booming IPO market reflects the strong and continuous development of SMEs in China’s private sector in the last three decades. According to the Ministry of Commerce, there are over 10 million registered SMEs, accounting for 99% of all businesses in China. And 99% of the country’s SMEs are private businesses. Furthermore, Chinese SMEs are responsible for 60% of the nation’s GDP, 70% of exports, 80% of urban employment and 70% of patents for technological invention. Undoubtedly, SMEs are cornerstones for the nation’s economic growth and social well-being. 

I SZSE’s growth markets

China’s recent IPO boom for SMEs started with the launch of the SME Board in 2004. Though originally designed as a pilot market for the smooth rollout of a venture market, SME Board flourished in its own right. In the last 6 years, the SME Board had 490 IPOs and raised US$53 billion. It not only channeled necessary funds and created value for listed SMEs, but also erected a beacon of hope for the vast number of ambitious SMEs. With 6 years of successful operation, the SME Board has proved the capital market’s effectiveness in growing emerging companies. In response to challenges exacerbated by the global financial crisis where SMEs were hard hit, China’s State Council decided to launch a new market known as ChiNext in SZSE in late October 2009. Under the leadership of the China Securities Regulatory Commission (CSRC), ChiNext took on the mission fostering innovative industries and helping transform the nation’s economic growth model. In one year’s time, ChiNext saw 134innovative growth companies offer shares, raising US$14.8 billion.  

The two growth markets serve SME issuers in both traditional and innovative sectors. The SME Board adopted almost the same listing rules as the Main Board. Though the SME Board maintained the Main Board’s mechanisms geared toward traditional manufacturing businesses, it offered an important opening toward private growth companies seeking financing support from capital markets. ChiNext, in comparison, offers less stringent listing rules, requiring shorter operational history and less profit for potential issuers. ChiNext is positioned to be more accessible to emerging companies from innovative sectors. .

II Powering growth on a sustainable track

SMEs play a crucial role as the Chinese economy moves away from overdependence on lavish resource consumption, cheap labour and high emission toward a more sustainable growth model driven by innovation. China’s 12th Five-Year Plan clearly lays out the new industries the nation aspires to develop. SMEs, adaptable and responsive to business opportunities, are quick to take position in emerging market niches. SZSE, under the guidance of CSRC, carefully designed IPO promotion and service programmes to groom and usher innovative SMEs into the capital markets. As a result, some trends have emerged in the SME Board and ChiNext Market where leading-edge innovators become movers and shakers in their industries. We have chosen some typical companies listed on the SME Board and ChiNext as examples to illustrate some new business models characterizing recent IPOs on SZSE. 

1 New Economy

The word “new economy” was coined during the Internet boom in late 1990s. It refers to business models based on communication networks. Thanks to its positive external effect, a network service becomes even more attractive with increasing number of users. It totally revolutionized traditional linear cost-output structure and created the possibility of exponential growth. However, there is one condition that a winning network business has to meet: a critical mass.

The latest statistics show that there are 460 million Internet users, and 760 million mobile phone users in China. Over 900 million Chinese people watched the opening ceremony of Beijing Olympics on TV. And the world’s most-watched sports game ever was an English Premier League soccer match, where two Chinese players showed up in the opposing teams. Convergence of different networks is underway in China. The link-up of Internet, mobile phone, cable and even electronic devices in China is likely to create one of the largest and most connected communication networks in the world. .

UltraPower (300002.SZ), listed on the ChiNext market, was founded in 2001, well after the Internet bubble burst. It founder, Mr. Wang Ning, was nonetheless convinced that network convergence would create vast opportunities in communication services. In 2008, the company developed Fetion, an instant messaging system for China Mobile. It enabled the mobile phone user to transmit text and pictures to his or her friend’s computer screen, and vice versa. With fast adoption by users for its convenience, Fetion soon reached a critical mass to launch a news pop-up, social networking, and other services. UltraPower now leverages its experience in instant messaging services to develop a mobile messaging service system for farmers. 

2 Chain services

Traditional service businesses in China tend to be small and family-held. Over the centuries, some brand names have stood the test of time and become iconic national legacies. Despite their fame and time-honored skills or recipes, they remain small. Their growth potential is constrained by boutique-style service and self-accrued funding. In this perspective, McDonald’s restaurants showed their Chinese counterparts a new approach to food service: standardization for cost-cutting and fast expansion.  

Chinesefood, with tastes largely dependent on chefs, is difficult to standardize and duplicate the way McDonald’s does. But it is not impossible. Quanjude (002186.SZ), listed on SME Board, was among the first to commercialize a traditional food brand and recipe on a large scale. For Chinese people, Quanjude is synonymous with authentic Peking roast duck. Today, Quanjude operates restaurants in Beijing, Shanghai, Chongqing, Harbin, Zhengzhou and Qingdao. The restaurant chain now offers roast-duck meals prepared and served in a standardized manner. A customer can expect almost the same experience wherever he or she goes to a Quanjude. Standardization helps the company gain economies of scale in procurement, marketing, cost management and knowledge sharing.

Home appliance store operator Suning (002024.SZ), which became listed on the SME Board in 2004, represents a variety of retail-chain issuers on SZSE. On the back of streamlined logistics services and riding on strong consumer demand in China, Suning has grown from 43 stores in 2004 to what is now over 1000 stores. The company has seen its assets grow by 50 times in value, profits rise by 30 times and share price up 60 times since listing.

3 Green industries

China’s effort to foster recycling and environmental technology comes out of necessity. For a long time, China’s economic growth put a heavy strain on its environment. Thanks to the government’s recent policies in support of environment-friendly development, green industries have taken center stage in response to environmental challenges.  

OriginWater (300070.SZ), listed on ChiNext market, was created by a group of returned overseas scientists in Beijing in 2001. The company envisioned an increasing demand for water treatment with fast urbanization in China. Thus the company developed patented MBR (membrane bioreactor) technology to effectively and economically filter and purify waste water. Its technology was adopted by major facilities like Beijing Olympic Park and National Grand Theater in Beijing.

Shenzhen-based GemHi-tech (002340.SZ), listed on the SME Board, is a company that specializes in recycling batteries. Batteries are convenient devices that, if improperly disposed of, may pose great danger to the environment. And cobalt, the metal that powers batteries, is extremely precious. Therefore, it makes perfect business and ethical sense to commercialize battery recycling. And thanks to support by the capital markets, GemHi-tech was able to expand production facilities in Hubei Province. GemHi-tech also collects electronic trash, reclaiming metals inside and reprocessing the remaining plastic materials into furniture. 

4 Cultural Ventures

With rising disposable income, Chinese people have greater demand for cultural products. Now China produces the world’s largest number of TV series. It is also the world’s third largest movie market, with an estimated US$1.43 billion in 2010, and averaging 30% year-on-year growth since 2005. And China has the world’s second largest number of newspapers in circulation. However, China has yet to produce a world-class media company. NewsCorp, listed on NYSE, with annual revenue of US$32 billion could dwarf the entire publication industry in China.

Though in its nascent stage, China’s cultural industries have already embarked on journey of commercial development with the help of capital markets. Huayi Brothers Media Group (300027.SZ) was the first Chinese movie maker to launch an IPO. Now, a year after its debut, it commands 40% of the market for locally produced movies. Its hit movie “Earthquake”, which reaped US$100 million, is likely to top the box office revenue chart for the year. China’s movie market is likely to reach US$4.5 billion by 2015, becoming the world’s second largest movie market. Furthermore according to Huayi’s Chairman, Mr Wang Zhongjun, the company’s IPO helps promote brand recognition and financial strength, and retain the best talent in the industry with equity-based incentive schemes. 

5 Biotechnology 

With emerging health challenges in the country, biological and medical research is called into action to help tackle epidemics like H1N1 and other common diseases. Though effective vaccines and medicine are always in high demand, they are hard to come by as bio-medical research is heavily capital-intensive and involves high uncertainty. The role of the capital market is, thus, to help leading biotechnology firms obtain the necessary financial resources to succeed in their R&D effort and mass-produce medical products.

Hualan Biological Engineering Co. (002007.SZ), listed on the SME Board since June 2004, is a specialized bioengineering company. It became well-known in 2008 when the H1N1 epidemic broke out, causing serious concern. Hualan was one of the first in China to produce safe and effective vaccines against H1N1. The company provided 15 million vaccines every month during the peak of the H1N1 outbreak.

Hepalink (002399.SZ), also listed on the SME Board, was founded by a biologist who succeeded in abstracting medicinal substance from pig bowels. The substance, proved to be effective to treat cardiovascular disorders, and is in strong demand both at home and overseas. Hepalink’s stock soared 70% on its debut, making Mr. Li Li, the founder of the company, the richest man in China on that day. 

6 Equipment Manufacturing

When trapped miners were finally lifted to the ground after a 68-day ordeal in Chile, everyone around the globe cheered, including engineers from a Shanghai-listed equipment manufacturer Sanyi Heavy Industry (600031.SH). The company provided the crucial crawler crane to lift the rescue capsule from  far underground. Sanyi represents a large number of Chinese equipment manufactures who can be called to action for daunting tasks. In fact, the capital markets have enabled many leading equipment manufactures, especially SMEs, to invest in capability-building and achieve technical excellence.

Hans Laser (002008.SZ) started as a small laser equipment dealer in Shenzhen. Mr. Gao Yunfeng, founder of Hans, was amazed by the wonders of laser technology. The high-power beam could cut with precision, weld faster and better than any human being, and the potential was huge for printing electronic circuit boards. Mr. Gao chose to launch his own venture in 1996. Eight years later, Hans Laser was listed on the SME Board of SZSE. Now Hans Laser equipment has been adopted by all top 500 industrial companies in China.

SIA Sun (300024.SZ), listed on ChiNext Market of SZSE, is a robotics technology company. Starting off as a commercialization project of the National Robotics Research Center, the company has turned many research projects into successful products to improve workplace productivity. Its robots now repair electric wires and control production lines. The robots not only replace human workers in unsuitable working conditions, but also perform their tasks with precision and tirelessness. 


III SME IPOs Unlock Value

The last 30 years has seen China gradually transit from a planned economy toward a market-oriented economy. The Chinese capital markets’ mission also evolved from mainly supporting large state-owned companies to helping market-responsive SMEs. IPOs have become a major channel of direct financing for Chinese SMEs. Along with the capital markets, many other doors have been opened to SMEs. By means of IPO, capital markets are consolidating financial services for SMEs, unlocking a value chain that benefits society at large.   

1 The booming SME IPOs have unlocked capital formation and value creation inaccessible to private businesses and the general investing public in the past. The private sector, though accounting for 99% of China’s business population, had been largely kept out of the capital market until SME Board began in 2004. Thanks to government support and new policies, SMEs of different ownership structures have been admitted into the capital market. Private businesses are now able to capitalize on their assets, knowhow and brands. Listed family businesses are subject public supervision and required to take social responsibility. Shares and other financial products have become available to investors of different risk appetites. Wealth management can also be facilitated by capital markets. Investors are thus able to share in the fruits of the nation’s economic growth. Furthermore the subsequent stable growth in listed companies on the SME Board and ChiNext market has helped create a virtuous cycle for continued IPOs. 

2 The booming SME IPOs provide a catalyst for private equity and venture capital investment. It is important for a start-up company to secure seed investment. However, in order to encourage investment in early-stages companies, there must be an exit strategy for venture capitalists. ChiNext has again showcased the equity market’s power to incentivize investment. Among the 134 listed companies on ChiNext Market, 89 involve venture capital investment. As calculated on the share prices on 30 September 2010, venture capitalists and private equity investors marked an average return of 11.36 times the original investment. In the city of Shenzhen alone, there are over 400 active venture capital firms, managing total funding of over US $10 billion invested in over 2,700 start-up and growth companies across the country. 

3 A financial supply chain has taken shape to help SMEs every step of the way. With increasing number of offerings by SMEs, banks, guarantee and collateral services, intermediary services have mushroomed to take advantage of new business opportunities. Big state-owned banks, which used to exclusively serve large state-owned companies, have established business divisions to help potential SME issuers, with the hope to retain them even after they mature. Some banks even coin the phrase “financial supply chain,” which means provision of tailored services for SMEs from early stages to IPO and afterwards. 

4 SME IPOs benefit the local economy. The idea of IPO by SMEs was unheard of to many local government officials back in 2004. Local officials were more familiar with bank lending than with capital markets. IPOs were slow in the beginning of the SME Board partly because there was a lack of government consensus at local levels on IPOs for SMEs. However, the market seemed to work its way from the bottom up. Some small townships emerged from the first round of IPOs in 2004-2006 with a cluster of listed companies within their jurisdictions. The Influx of IPO proceeds made remarkable contributions to local economies. Talents moved into these small towns, attracted by higher salaries and greater opportunities in listed companies. Business boomed as new investment helped upgrade R&D, marketing and technology adoption. Local issuers also helped create jobs as suppliers and logistics providers clustered around them. Government was also happy to see tax revenue increase. These small towns soon found themselves closing their wealth gap from larger and more established cities. A small county named Jiangyin in Jiangsu Province, noted for its pioneering effort in promoting SME IPOs, became one of the most visited towns in China. Jiangyin is now home to 28 listed companies, which raised a total of US$3.1 billion. Jiangyin ranks top in both IPO proceeds and number of IPOs among Chinese townships. It produced 10% of China’s listed companies on one ten-thousandth of the nation’s land and with one thousandth of the population. With a GDP of US$26 billion, Jiangyi is not only top of the nation’s 500 strong township economies but also a bustling cluster of SMEs from a diversity of sectors. The benefits of SME IPOs gradually became visible to government officials at local levels in other regions, who swarmed to Jiangyin for advice for their own promotional policies. 


V Facing up to challenges in SME IPO

So far it has been a rosy picture for China’s SME IPO market. Liquidity is ample thanks to relatively high savings by Chinese people, and the government’s relaxed monetary policy. And offering prices are high partly because supply of SME IPOs still falls short of market demand. However there is no reason for complacency and the future is not without challenges. Investor confidence comes from stable performance of issuers. Good corporate governance, transparency and strict market oversight are the necessary conditions for continued sound performance in IPOs. Retail investors provide the majority of market liquidity in China. Retail investors with portfolio or assets value less than 1 million RMB yuan (US$149,700) generate 67% of the total market trading value in SZSE. And they are more vulnerable to market manipulation than seasoned institutions. Growth markets are, by nature, more volatile and uncertain than main-board markets. As a result, protection of investors, especial individual investors, are important safeguards for market integrity and investor confidence for IPOs

1 Controlling first-day speculation

Large first-day price hikes were a major concern for regulators. Lured by profits, retail investors tend to chase high prices in a speculative mood. In response to first-day speculation, the CSRC implemented a more market-oriented IPO pricing system at the beginning of this year. SZSE also introduced a circuit-breaker mechanism to calm down the market during the first-day price hikes. At present, the average first-day gain in ChiNext market is about 30% percent, down from 130% in the beginning of this year.  

2 Investor Education Programme

With limited analytical tools and research capacity, retails investors are susceptible to herd mentality, rumors and irrational trading behaviours. It is therefore important to provide retail investors with necessary information and tools to understand the market and take a rational attitude toward investment. To this end, SZSE went on TV, radio, newspapers and magazines to publicize educational information for investors. Over 600 TV and radio programmes are aired each year. SZSE also provided 350,000 booklets titled “Getting to know the ChiNext Market” and over 20,000 education DVDs to investors free of charge last year. Over 220,000 people have participated in a knowledge contest about ChiNext market, and over 15,000 investors have tried a mock trading programme for a simulated experience of trading since the middle of last year.  

3 Investor protection and suitability programme

With greater volatility and uncertainty than the Main Board, ChiNext securities may not be suitable to all investors. It is important that the market open only to investors with adequate experience and the ability to bear risk. To this end, SZSE set up a ChiNext Investor Suitability Programme, requiring that an individual investor have at least two years’ trading experience before opening trading accounts. Those who have less than two years of trading experience but insist on joining the market must hand-copy a special declaration of risk understanding. 

SZSE, working with frontline member brokers, carefully registered the necessary information on all investors in the ChiNext market, providing a basis to offer the right financial products to the right investors.  

4 Strengthened Information Disclosure

In comparison with the Main Board, information disclosure requirements for ChiNext companies have been strengthened. For example, risk alerts must be written on prominent positions in the prospectus. In order to prevent first-day speculation, issuers are required to publish risk alerts on the first day of listing to clarify relevant issues and disclose major risks involved. Within one month after release, listed companies are also required to hold an annual report briefing to explain their business strategy, operational performance, new product or technology development, financial results, investment projects, sales and purchases of core technology, changes in core technology teams or key technical personnel.   

5 XBRL-based electronic information system facilitates access to information

With increasing information demands from diverse market participants, it can be a challenge for the exchange to simultaneously satisfy everyone’s needs. Convinced that a universal computer language is basic infrastructure for a unified information system, SZSE was the first in China to adopt XBRL (extensible business reporting language) in 2003. SZSE developed an XBRL-based electronic disclosure system comprising of data filing, management, supervision and dissemination. The issuer can easily upload structured information to be disclosed according to a set of taxonomical rules in line with IFRS; SZSE manages and supervises the files before signing them off for public disclosure on designated websites. Thus the system provides a complete electronic solution from corporate disclosure to fair speedy information access for investors. Furthermore, an investor-relationship website is also available for direct communication between investors and all SZSE-listed companies.  


SMEs are an integral part of the Chinese economy. They help meet consumer demands by developing innovative, effective, even disruptive technologies, and creating new forms of services. SMEs have risen to push back our horizons and fill demands left open in the rich texture of modern commerce. In this sense, small is beautiful.   

However, beauty resides in not only the nimbleness and flexibility of SMEs, but also a supportive system ready to help them move up to a higher stage. The beauty also lies in the power of the market’s invisible hand, which allocates the right resources to the right companies, who, in turn, are expected to improve conditions of life for human society. People often say that beauty is in the eyes of the beholder. We are convinced that the capital market tends to have the right vision for beauty.

[1] According to Ministry of Commerce of China, SMEs are defined differently in different sectors. Industrial SMEs

employ not more than 3000 people with yearly revenue less than US$44 million. Small industrials employ not more than

300 people with annual revenue less than US$6 million. The ceiling criteria for SMEs in food and catering service in

clude employment of not more than 800 people and yearly revenue under US$20 million. Small catering services tend to

have fewer than 400 employees and US$4.5 million in annual revenue.