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JPM Decorative Letter - Watermark J

Eyes on Asia’s Path to Recovery

As COVID-19 restrictions ease in China, J.P. Morgan’s Corporate Finance Advisory explores the path toward economic repair.

June 26, 2020

Momentum is Mixed

In early April while other nations remained in lockdown, China began lifting restrictions and reopening the economy in Wuhan, and other affected areas of China, after more than two months. With its reopening, nations and policymakers are looking to China as an example for economic recovery, although such a comparison may be challenging given unique Chinese characteristics such as its overall response to the virus and its ability to enforce full lockdowns, as well as its restrictions on foreign capital inflows and outflows. While the focus is on the Chinese path to stabilization and economic growth, the recent return of partial lockdown measures in Beijing has raised questions about the potential impact of a “second wave” and highlights the unpredictable road to recovery.

Positive Momentum toward Economic Repair

Pre-pandemic levels of China’s Purchasing Manager Index (PMI) were 50.2 in December and November of 2019 (>50.0 indicates an expansion)1. The index dropped 14.3 points from January to February before quickly rebounding in March to 52.0.

With the easing of travel restrictions, average daily flights from China have increased ~60% since the end of March. China’s retail segment is also showing signs of life after declining 21% in January and February. J.P. Morgan Research expects strengthening retail and consumer trends, with tailwinds from consumption repatriations and government stimulus. Although the May sales report recorded a 2.8% YOY decline, this was an improvement from April’s 7.5% YOY decline.

The pandemic had a major impact on China in Q1, with GDP contracting 6.8%1. However, J.P. Morgan Research is forecasting Q2 China GDP to moderately grow at 1%, with a return to normalized growth in Q3 to 5.1%2.

Group 3 Created with Sketch. The pandemic had a major impact on China in Q1, with GDP contracting 6.8%. However, J.P. Morgan Research is forecasting Q2 China GDP to moderately grow at 1%, with a return to normalized growth in Q3 to 5.1%.

U.S. Likely to Experience a More Prolonged Recovery

The U.S. PMI index has experienced a more gradual decline from 50.9 in January to 41.5 in April, before rebounding slightly in May to 43.1.3

Since the end of March, the daily average number of U.S. flights has increased negligibly due largely to travel restrictions and stay-at-home mandates. On May 15, the U.S. Census Bureau reported a record 16.4% decline in U.S. retail sales, nearly double the previous month’s decline of 8.3%. Economists are forecasting unemployment to remain in the double digits, currently at 13.3% as of March, which will continue to be a downside driver to a path to recovery.4

In contrast to China GDP growth, which is showing signs of a V-shaped recovery, the U.S is still largely feeling the effects of the pandemic. U.S. Q1 GDP declined 4.8%, however economists expect the brunt of the recession to be borne by Q2’s GDP, which is expected to decline ~40% from the previous quarter. J.P. Morgan Research forecasts GDP will continue to decline this year, with growth not occurring until a full year later in Q2 2021 at a quarterly change of 10.4%.5

Activism in Asia Ramps Up

Once only representing 15% of global activist investor campaigns in 2012, Asia Pacific now comprises more than a quarter of global campaigns. However, Asia has a long way to go before activism is as pervasive as it is in other regions, such as the U.S. Globally, four out of five activist campaigns demanding a board seat in the first quarter of 2020 were successful. While Asia lags other locations when it comes to the percentage of board directors who are independent, could 2020 be a turning point based on global success rates?

Campaigns typically target blue chip companies in Asia Pacific, similar to other regions, but approaches vary. Notably, cultural differences in business practices are likely driving alternate activism methods in Asia. Activists have found it necessary to alter their typical course of action in order to find success, primarily by accepting the need for greater patience. Whatever their goals entail, activists in Asia are committed to their campaigns.

Group 3 Created with Sketch. Notably, cultural differences in business practices are likely driving alternate activism methods in Asia.

For example, Elliott Management has held a stake in Bank of East Asia (“BEA”) for years, and is finally beginning to see the company respond to its demands. Elliott initially sued BEA in 2015 for access to information about a share placement transaction. After gaining this information, Elliott sued again, alleging the share placement made the company “takeover proof” and entrenched management. Elliott’s most recent suit was due to be heard in May of this year. However, BEA retained financial and strategic advisors to review its business in March, leading to a halt in this legal action by Elliott.

History has shown that activists are willing to invest not only time (measured in years) but also financial resources to see their campaigns through. In light of these facts, engaging with advisors proactively to evaluate activist proposals and risks could be beneficial for management in this region.

Chinese Companies Weigh Uncertainty of Future U.S. Relations and Implications for Listing Venues

Congress is reportedly looking into creating a law that would mandate the delisting of Chinese firms unless certain conditions are met, which may be nearly impossible to comply with. This news has increased uncertainty among would-be U.S. listers. Some of these firms, such as JD.com and NetEase, have already listed in Hong Kong, where they have found initial strongly positive local market reactions. Some investors assert firms that list on the Hong Kong stock exchange, instead of U.S. exchanges, are able to achieve a higher valuation multiple. One theory is that U.S. investors’ home bias may limit the enthusiasm for foreign companies’ stock trading on U.S. exchanges.

The trend of choosing to list on the Hong Kong stock exchange has been prevalent for years, following the announcement in April 2018 that allowed companies with multi-class share structures. This change ultimately led to a 23% increase year-over-year for Hong Kong IPOs in 2019, pushing the exchange to the number one rank globally; projections for 2020 remain elevated. New uncertainties provide another data point for firms to potentially favor listing in Hong Kong.

The Hong Kong stock exchange’s issuer-friendly policies and the potential for a valuation premium, regardless of underlying rationale, continue to provide a strong argument for global firms to list their Asian subsidiaries in Hong Kong. Some of these advantages can ultimately lead a firm to pursue an IPO of a subsidiary over other forms of monetization, such as a spin-off or carve-out. It remains important for firms to stay aware of ongoing developments in political dialogue and market environments to make informed strategic decisions.

1National Bureau of Statistics of China
2J.P. Morgan Markets-China Economic Forecast
3ISM report
4U.S. Bureau of Labor Statistics
5J.P. Morgan Markets-U.S. Economic Forecast

The Corporate Finance Advisory team examines themes or trends that serve as a source of thought-leadership for management teams. Areas covered traditionally include corporate strategy and M&A, capital markets, capital structure/ allocation, market intelligence, or other accounting and regulatory subject matter.

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