The Necessity and Suggestions for Enhancing Central SOEs' Market Value (Source: Chin@Moments)

Source: Chin@Moments (Qin Shuo Peng You Quan). The contents of this article does not represent the view of SSE.

The State Council Information Office held a press conference on the morning of January 24, 2024, focusing on strengthening core functions, enhancing core competitiveness and better realizing high-quality development of China's centrally-administered state-owned enterprises (SOEs). Xie Xiaobing, Head of the Bureau of Property Right Management of the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council, said at the conference that the SASAC will further explore how to include market value management into the performance assessment of central SOE leaders.

The China Securities Regulatory Commission (CSRC) convened the 2024 Work Conference from January 25 to January 26, 2024, emphasizing the need to accelerate the building of a valuation system with Chinese characteristics, support listed companies to become better and stronger by means of market-oriented merger, acquisition and reorganization, promote the inclusion of market value into the assessment system of central SOEs, and explore how to increase constraints on low-valued listed companies from information disclosure and other aspects.

While the market is falling, central SOEs are also experiencing a sharp decrease in market value, and their market value accounts for a low proportion of the total market value. However, in fact, central SOEs have become more competitive in recent years. Apparently, their current market value does not match their intrinsic value. This is due to the capital market's deviated valuation of central SOEs as well as regulators' absence of a close connection of performance assessment to market value of central SOEs.

The undervaluation of central SOEs may have various negative effects, such as low financing amounts, high financing costs, and unfavorable conditions for funding social security accounts. Therefore, it is suggested to enhance the market value of central SOEs and make them bigger and stronger through market value growth.

Negative Effects of Serious Undervaluation of Central SOEs' Market Value

Currently, the market value of central SOEs is severely underestimated. As of the closing of February 2, 2024, the total market value of A-share listed central SOEs (466 companies in total) was only RMB 18.3 trillion, accounting for 27% of the total market value of the Shanghai and Shenzhen stock markets (RMB 67.6 trillion), while the total profits and operating revenues of these central SOEs exceeded 50% of all listed companies.

In terms of the commonly used valuation indicators, such as the price-to-earnings ratio (PE ratio) and price-to-book ratio (PB ratio), the valuation of central SOEs is at historically low levels, and investors have not yet fully explored the real intrinsic value of central SOEs.

Low market value implies that central SOEs are undervalued, that is, the same assets are marked as lower value by market investors, which brings various negative effects to the operation of central SOEs.

1. When a central SOE has low market value, its refinancing will raise less money with the same number of shares; its credit rating will be affected and it has to face a higher financing cost in case that its bonds are to be issued.

2. The low market value of central SOEs is also unfavorable for funding social security fund accounts. To replenish social security fund accounts, the state allocates 10% of the shares of some central and local state-owned and state-holding large and medium-sized enterprises and financial institutions to the Social Security Fund for management. However, if the market value of central SOEs remains low for long, the value of their shares allocated to the Social Security Fund will be minimal, which is not conducive to funding social security accounts and the safe and stable operation of residents' social security accounts.

Analysis of Reasons for the Low Market Value of Central SOEs

There are several reasons for the low market value of central SOEs, which are related to regulatory requirements, investors' valuation system, and central SOEs' own positioning.

1. Regulators lack the assessment of market value of central SOEs as a general indicator. The assessment tends to focus on three financial statements (income statement, cash flow statement, and balance sheet), with less emphasis on market value as a general indicator.

The SASAC assesses central SOEs based on various criteria, including the traditional "two profits and four ratios" ("two profits" refer to net profit and total profit, "four ratios" refer to profit margin of operating income, overall labor productivity, R&D investment intensity, and asset-liability ratio) and the new "one profit and five ratios" ("one profit" refers to total profit, "five ratios" refer to asset-liability ratio, return on equity, operating cash ratio, overall labor productivity, and R&D investment intensity). However, these assessments emphasize specific financial indicators and lack the assessment of market value as a general indicator.

2. Traditional valuation methods are flawed, resulting in the low market value of central SOEs. Such traditional valuation methods, including PE ratio, PB ratio, price-to-sales ratio, EV/EBITDA, dividend discount model, and discounted cash flow model, are all based on financial indicators, assuming that the three financial statements are able to fully reflect an enterprise's value. But In fact, central SOEs have many social functions, and the extended value beyond the three financial statements is not covered. So, under the traditional valuation methods, central SOEs are sure to be undervalued.

3. Some central SOEs have low market value, because they know little about capital market and their leaders are familiar with operations rather than capital. Particularly, senior executives from operational backgrounds within central SOEs, good at operation management but unacquainted with capital market, even oppose some capital market practices, such as conducting reverse roadshows to investors, releasing optimistic signals to the capital market, and maintaining good communication with investors at any time.

As a result, corporate operation and market value management are separated rather than combined, and the company's market value remains sluggish for long and inconsistent with its good intrinsic value.

Suggestions for Enhancing Central SOEs' Market Value

1. The "one profit and five ratios" indicator system shall be further improved to include market value assessment. The system focuses on specific operations but lacks a general assessment indicator. It is suggested that the SASAC establish market value assessment indicators, which can include absolute market value indicator (i.e. absolute growth of market value) or relative market value indicator (i.e. relative change with the overall market value).

By establishing market value assessment indicators, senior executives of central SOEs can better recognize the importance of market value, thus improving investor relations and making use of the capital market for the development of central SOEs.

2. Traditional valuation methods shall be either improved or abandoned as appropriate, and the valuation system with Chinese characteristics shall be set up. Traditional valuation methods have many drawbacks and are disadvantageous for the valuation of central SOEs. CSRC Chairman Yi Huiman said on November 21, 2022, that deep and systematic thinking is necessary so as to identify the basic meaning, realization path and key tasks of a modern capital market with Chinese characteristics, grasp the valuation logic for different types of listed companies, and explore the ways to build a valuation system with Chinese characteristics.

The traditional valuation system only measures a company's intrinsic value, and its extrinsic value is excluded. Enterprises all have a social nature and assume some social functions, but some may assume small social functions, while others may assume bigger social functions. Particularly, some central SOEs assume substantial social functions and play an indispensable role in the national economy. For instance, three telecom giants and three oil giants (PetroChina, Sinopec, and CNOOC), which took the lead in launching the "valuation system with Chinese characteristics" in the last year, all assume substantial social and public functions. Some of them were even born out of relevant ministries and commissions, and the Chinese economy would struggle to function without them. Apparently, some national defense and military enterprises have greater social value than economic value. The existence of these enterprises is not solely for profit-making purposes. However, the functions beyond the financial statements are hard to be reflected under the traditional valuation methods. As a result, these central SOEs have been undervalued for long. The SASAC shall study and develop valuation methods and logic with Chinese characteristics in accordance with central SOEs' characteristics, so as to have central SOEs truly and fully valued.

3. Central SOEs shall be encouraged and guided in due time to repurchase the shares when their market value is low. In China's capital market, there has been a prevailing notion of emphasizing stock market financing while neglecting stock market investment. However, this notion is not always right. In reality, financing and investment interact with each other in the capital market. When an enterprise is overvalued, it may turn to financing and obtain more funds with a smaller number of shares; when it is undervalued, it may repurchase the shares to enhance its valuation, and repurchase more shares with a smaller amount of money.

If market value is established as an assessment indicator, central SOEs will be motivated to enhance their market value. For example, it could be considered to stipulate that every year, central SOEs may be allowed to use no more than 20% of dividends to repurchase the shares, and this will make them realize that share repurchase is also an effective investment behavior. In fact, Sinopec has performed well in the stock market in recent years, and its stock price is rising despite a sluggish market, which can be attributed in part to its continuous share repurchase since 2022.

4. It is essential to guide central SOEs to attach importance to the concept of ESG (Environmental, Social and Governance) and to regularly release and improve their ESG reports. ESG ratings evaluate an enterprise's real value by assessing its sustainability and impact on social value from three dimensions: environmental, social, and corporate governance, which is becoming an investment concept and receiving more and more attention from investors across the world.

By attaching greater importance to the ESG concept, an enterprise's value will be better recognized by investors and its market value can be enhanced as well. Central SOEs have always placed more emphasis on social benefits than private enterprises, which in essence is consistent with the ESG concept, and now they need to enhance their market value in the capital market by releasing ESG reports and other means.