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UPDATED: May 22, 2014 NO. 21 MAY 22, 2014
Can Preferred Shares Gain a Foothold?
Market participants should not be too quick to judge
By Lan Xinzhen

Though the preferred shares merely account for 1 percent of the company's original share capital, if completed, Guanghui Energy's 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 company's 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, it's difficult to foresee the fate of the preferred share, noted Li Aimei, an analyst from Beijing-based Guodu Securities Co. Ltd.

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 don't participate in the company's 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, it's 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 China's 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."

Email us at: lanxinzhen@bjreview.com

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