November 2016Investment insights
by Richard Watt, Investment Commentator
Something amazing is about to happen in China: its second stock market, the Shenzhen Stock Exchange, will soon open up to international investors. This is amazing not because it will offer better investment opportunities in China, but because it represents a key part of the incredible story of the Shenzhen Stock Exchange, the companies listed on it, and the city it sits in.
The city of Shenzhen is a 30-minute train ride from central Hong Kong. I first saw it in 1985, when I was 10. It was through the lens of a British Army night-vision camera on top of an observation post on Hong Kong’s border with China. Back then, at night, the camera was essential – without it there was not much to see. Paddy fields gave way to a handful of low-rise factories, shut down and lights switched off for the night.
It didn’t stay like that for long.
Just a few years before this, Deng Xiaoping announced that the village of Shenzhen and its surrounding area would become China’s first Special Economic Zone, allowing foreign and domestic trade and investment to be conducted without the need for central government approval.
The impact was immediate and awesome. It triggered what would be the most spectacular growth story of any city, ever. The one-time fishing village grew from a population of 30,000 in 1980 to 300,000 by the time I saw it in 1985. In 1990, it hit its first million and today it is home to 12 million residents, rising to over 15 million in certain months. (London once had a population of 30,000 – in 1492, the year Columbus discovered the Americas).
The migration to Shenzhen was fuelled by a massive influx of foreign investment to the expanding city. Cheap labour was put to work manufacturing just about any cheap product the outside world wanted. Plastic toys, clothes, shoes, watches, jewellery, and counterfeit goods rolled off production lines and out to market, first through Hong Kong and then through Shenzhen’s own port which was built out at the same startling speed as the population arrived.
State-financed infrastructure projects provided much-needed work for hungry migrants. Skyscrapers were built at the same time that metros were dug. Some of China’s tallest buildings went up at a rate of two-and-half days per floor. Schools, colleges, hospitals, and an international airport appeared almost out of thin air. Shenzhen became known as the “instant city”.
It quickly attracted the most ambitious that China had to offer. If you wanted to get on or you had a great idea, you headed to Shenzhen. Ren Zhengfei, former deputy director of the People’s Liberation Army engineering corp, wanted to get on, and he saw the opportunity. He founded Huawei in Shenzhen in 1987 and his company’s growth was perhaps only matched by the speed at which the city was also expanding. Today, his company services a third of the world’s population with information and communications technology solutions, products and services. Huawei’s 4G equipment is used in 140 capital cities and in the past decade the company has invested US$30.5 billion into research and development. In 2014, it filed more patents than any other firm and last year it generated revenues of US$60.8 billion, a 37% year-on-year increase. A Shenzhen classic.
Companies like Huawei, along with western tech giants like Apple who also set up vast manufacturing hubs in Shenzhen, helped develop the city’s fledgling labourers into a more experienced and skilled force. As skills and wages increased, low-value manufacturing moved inland or out to Asia’s frontier markets.
An innovation hub
Before they knew it, the migrants of Shenzhen were manufacturing and assembling some of the most complex electronics the world had ever seen. The focus was now on smartphones, drones, lithium batteries, electric cars and complex telecommunications equipment . This time, much of it didn’t head to the ports of Hong Kong and Shenzhen. Instead, it made its way inland to meet the burgeoning needs of the country’s booming middle class.
Some of China’s biggest and best-known companies set up shop in the city.
Tencent, with a billion active users of its messaging services, was founded in Shenzhen 16 years ago. Its listing in Hong Kong has been one of world’s best performing stocks of the past decade.
BYD, established in Shenzhen in 1995 and now the world’s largest supplier of rechargeable batteries, launched the world’s first dual-mode electric car in 2008 and the first electric taxi in 2010.
The list (and the superlatives) go on. ZTE, China’s biggest listed telecoms equipment company, is based in Shenzhen, as is Gree, the world’s largest supplier of air-conditioning units. DJI, the world’s leading supplier of commercial drones, is headquartered there, where it says it “benefits from direct access to the suppliers, raw materials, and the young, creative talent pool necessary for sustained success”.
Shenzhen’s stock market opened in 1990 and today it is the seventh-largest in the world, with a US$3.2 trillion market cap. It is home to China’s fastest-growing companies, in sectors including technology, pharmaceuticals and clean energy. It contrasts starkly with Shanghai’s stock market which is dominated by state-owned banks and oil companies.
While not all of Shenzhen’s biggest and best companies I have mentioned are public (and there are some that are not listed in Shenzhen but have listed overseas, as ADRs in the US or as H-shares in Hong Kong) the imminent opening up of the Shenzhen stock market through a stock connect scheme with Hong Kong gives foreign investors further access to China’s growing ‘new economy’ sectors, while giving the companies access to foreign capital.
The Hong Kong-Shenzhen Connect will put about 880 companies (totalling US$1 trillion market cap) firmly into the reach of global investors. Included in this are companies listed on the ChiNext, China’s version of the Nasdaq, which will be opened up to institutional investors.
Optimism for the future
Shenzhen is just one city in China; it is not the biggest and in some ways it is unique, so it does not represent China as a whole. Yet, having seen it grow from almost nothing to a thriving and innovative megacity that is home to more than twice the population of Hong Kong, it’s difficult to feel anything other than a deep sense of optimism for the city and for China as whole.
The economy faces a number of headwinds and no doubt in the months to come we’ll be reading more about China’s debt problems and housing market issues. But if you’re an investor who believes that some of the best and most innovative companies and ideas in the next decade might just come out of a city like Shenzhen – as I do – then the opening up of this market is an early Christmas present for you.
Welcome to Shenzhen.
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