Making Money with Chinese IPOs

Chinese stocks are again the focus of increased attention and speculative trading. In China, the benchmark Shanghai Composite Index (SCI) had been rallying. It’s up over nine percent this year, which is encouraging given that the index lost 14.31% in 2010.

An area that we continue to see some action is in Chinese initial public offerings (IPOs), but to a lesser degree due to the negative publicity of Chinese reverse mergers.

There are so many Chinese penny stocks and micro-cap stocks waiting to cross the ocean in search of U.S. dollars and exposure. The key to successful stock picking in this area is research.

In a report compiled by legal firm Pillsbury, over 30% of the 200 companies interviewed said they would prefer to seek a listing in the U.S. About 45% preferred Hong Kong or China.

We have seen numerous successful Chinese IPOs over the past two quarters.

In December 2010, Chinese online video superstar Inc. (NASDAQ/YOKU), which was subscribed at $12.80, surged to close at $33.44 on its first day of trading, up a staggering 161% in a day! Fast forward a few months and YOKU is trading at over $65.00, up over 400%. The attraction here is that the company has a 40% penetration rate in China’s massive Internet market in which there are over 420 million people. Can you hear the cash register?

In my view, I feel that the buying frenzy is somewhat optimistic. Another example is Chinese online real estate portal SouFun Holdings Ltd. (NASDAQ/SFUN), which debuted at $67.00 on September 17 and surged to nearly $100.00 before initiating a four-for-one stock split on February 18. The stock is holding at over $23.00, or $92.00 on a pre-split basis.

An interesting company that is set to debut here is China-based Zenix Auto International, a manufacturer of commercial vehicle wheels for China’s aftermarket and original equipment manufacturer (OEM) markets along with over 30 countries worldwide. Estimates peg the company’s market share at 16.6% in 2009, according to Frost & Sullivan. For the year to December 31, 2010, revenues came in at $485 million, up 50% year-over-year. Annual earnings were $50.0 million, or $0.31 per diluted share. The lead underwriter is Morgan Stanley.

The key to trading Chinese IPOs is to wait for several weeks and watch to see if the stock settles down in a set buying range. Buying on the first day can generate some impressive returns, as we saw with and SouFun, but it also makes you vulnerable to profit-taking, especially if you are not one of the lucky clients who did not get in near the IPO price.

The rule of thumb is being patient: follow the stock and wait for weakness to buy. This is only fitting, as patience has been a critical trait in China for thousands of years.