Can Preferred Shares Gain a Foothold?

By+Lan+Xinzhen

On April 24， Guanghui Energy Co. Ltd.， headquartered in Urumqi of northwest Chinas Xinjiang Uygur Autonomous Region， announced its plan to issue preferred shares， making it the first A-share company to make such an announcement since the regulator gave the green light to this new type of funding. Unexpectedly， the move quickly aroused tremendous discontent among the companys investors. From April 25 to May 8， its share price plummeted by 20 percent.

Preferred shares are commonplace in the developed capital market， but remains a novelty in China. On March 21， the China Securities Regulatory Commission （CSRC） unveiled the Preferred Stock Pilot Administrative Measures， stipulating that only three types of listed companies are allowed to issue the shares： Shanghai Stock Exchange 50 index members （the largest by market capitalization）； companies planning to acquire other listed companies by issuing preferred stocks for payment； and companies planning to buy back common stocks to decrease their registered capital by issuing preferred stocks as payment.

As investors give the cold shoulder to the preferred share， there have been concerns that the new funding vehicle may be not compatible with the Chinese market.

Investors offended

According to its statement filed with the Shanghai Stock Exchange， Guanghui Energy will sell no more than 50 million shares to raise no more than 5 billion yuan （$800.5 million）， in order to fund a railway project and replenish working capital.

Guanghui Energy in particular took market participants aback with its preemptive move. Before that， high hopes were held for the big four state-owned commercial banks and Shanghai Pudong Development Bank.

Without a doubt， Guanghui Energy will stand to benefit greatly from such a massive financing action. However， investors who initially felt like testing the water are not satisfied with whats on offer.

The 5 billion yuan （$800.5 million） raised accounts for 48.92 percent of the companys net assets at the end of the first quarter， almost reaching the 50-percent upper limit. Moreover， 3.5 billion yuan （$560.35 million） will be used to replenish Guanghuis working capital， which has aroused criticism concerning money encirclement and the company fulfilling its cash flow gap.

In addition， the floating dividend rate is unable to secure a return on investment， and without call provisions， the company can transfer risks to investors by reducing the payment of stock dividend.endprint

In retaliation， shareholders began to dump the shares of Guanghui Energy. As a result， on April 28， its shares registered a limit down.

Wang yong， an analyst with CITIC Securities Co. Ltd.， argued that the companys plan to issue preferred stocks seemed more focused on money encirclement than financing.

Established in 1999， Guanghui Energy is a large privately owned energy company in west China. It is mainly engaged in natural gas and coal businesses and was listed on the Shanghai Stock Exchange in May 2000.

According to its financial report in the first quarter， by the end of March， its asset-liability ratio had stood at 66.8 percent， approaching the 70-percent alarm level.

At the same time， its short-term loans reached 6.07 billion yuan （$971.81 million） and debts payable hit 2.53 billion yuan（$405.05 million）， a record high in the history of its public listing. Factoring in other accounts payable， its liabilities amounted to 9.79 billion yuan （$1.57 billion）. By paralleling it with the 5.16 billion yuan （$826.12 million） of its monetary capital and accounts receivable in the first quarter， a financial gap as huge as 4.62 billion yuan （$739.66 million） can be envisaged， which indicates a weakness in debt-paying ability and cash flow.

Though the preferred shares merely account for 1 percent of the companys original share capital， if completed， Guanghui Energys net assets will be elevated by 42.72 percent， while the asset-liability ratio will fall from 66.68 percent to 58.37 percent. In this way， financial pressure on the company will be significantly reduced.

In addition， if the preferred shares enjoy a high dividend rate， holders of common stocks will suffer from dwindling earnings. In 2013， the companys net profit was about 750 million yuan （$120.08 million）， with the rate of return on common stockholders equity stopping at 8.95 percent. Presuming a dividend yield rate of 8 percent， the 5-billion-yuan （$800.5-million） preferred shares will slice 400 million yuan（$64.04 million） from the total profits harvested， while common shareholders， who hold 99 percent of the total stocks， would only earn half of the total dividends.

Worries over prospects

Given the cold welcome Guanghui Energy received， its difficult to foresee the fate of the preferred share， noted Li Aimei， an analyst from Beijing-based Guodu Securities Co. Ltd.endprint

Li said that the preferred share is targeted at multiplying the selection of financing tools for companies with strong profitability， and helping state-owned enterprises， financial companies in particular， improve their management and carry out reforms. Moreover， it will also reinforce the overall strength of leading banks and insurers by speeding up consolidation and restructuring.

If the preferred share fails to win favor at its debut， it will be quite difficult for the pilot project to carry on in China. Preferred shares are something between common shares and corporate bonds， commented Li. In allocating profits and liquidating assets， holders of preferred shares come before those of common shares， but they dont participate in the companys decision making. When a company only cares about attracting capital， common shareholders will suffer. Only when the company strikes a balance between the two， can the preferred share win extensive recognition in the market.

This is not to say that the preferred share has limited market prospects. In developed economies like the United States and Europe， its a different story. By 2013， the value of preferred shares there had totaled$390 billion， 85 percent of which was issued by financial companies.

To fend off the shocks of the global financial crisis， the U.S. Government once purchased preferred shares worth $125 billion from nine major banks， such as Citi Bank and J.P. Morgan Chase， in an effort to shore up the capital adequacy ratio of financial institutions and alleviate financing pressures.

When the CSRC first unveiled the Preferred Stock Pilot Administrative Measures， domestic securities traders were quick to sing their praises. As China Merchants Securities put it in one of its analysis reports， the pilot will definitely reinforce Chinas joint-stock system reform. Guodu Securities also believes the move will give a substantial push to the local capital market.

Li attributed the failure Guanghui Energy experienced to its bad performance， and suggested that market participants should not blindly deny the potential of the preferred share.

Preferred shares will help companies boost direct financing， replenish capital funds， lower debt ratio and optimize financial structure. In addition， it will push forward the ongoing industrial consolidation by financing mergers and acquisitions.

Preferred shares will offer long-term funds like social security and insurance funds a new investment channel. Since preferred shares provide relatively stable returns and enjoy privileges in dividend distribution and compensation， investors will show a strong willingness to invest.

Preferred shares have something in common with both stocks and bonds， and will diversify the categories of securities， improve corporate governance， and promote a stable and healthy capital market.

Li believed it will win great popularity in days to come. “People may quickly change their mind when the next preferred share hits the market.”endprint