INTERNET: MSCI Seal of Approval to Boost Baidu, Alibaba

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Bottom line: The MSCI’s inclusion of US-listed Chinese stocks like Baidu and Alibaba in some of its emerging market indexes will support the shares by attracting more long-term investors.

Alibaba, Baidu get support from MSCI inclusion

Investors who previously looked enviously at Chinese Internet stocks but were too afraid to buy due to their volatility have new reason for confidence, with word that one of the world’s top index compilers will include the country’s top names in some of its indexes. The move by MSCI has been long overdue, and comes just months after the global index compiler disappointed China boosters by declining to allow Shanghai- and Shenzhen-listed A-shares into its emerging markets indexes.

This particular move will also come as a welcome development to people who argue that China’s best companies are better served by listing their shares in overseas markets like the US and Hong Kong rather than at home. Many Chinese Internet companies that previously listed in New York have been abandoning the market recently by launching privatization bids, with an aim of eventually re-listing in China to try for better valuations.

According to the latest reports, MSCI will add New York-traded American Depositary Shares (ADSs) for 14 Chinese companies to some of its indexes, including its MSCI China Index and its MSCI Emerging Markets Index. (English article) The move will allow 2 of China’s biggest Internet names, Alibaba (NYSE: BABA) and Baidu (Nasdaq: BIDU), into the indexes, and was part of a broader semi-annual review that welcomed 21 foreign-listed stocks into the MSCI’s indexes.

Stocks typically rise when they get included in major global indexes, as such a move is an unofficial nod of approval for other fund managers to invest in those companies. In this case the addition had a mildly positive impact for Alibaba and Baidu shares, which both rose slightly in after-hours trading in New York. The move doesn’t come as a huge surprise, and the fact that both stocks have rallied quite a bit over the last month means more short-term rises may be limited despite the MSCI’s positive decision.

Power of Overseas Listings

More broadly speaking, this kind of decision reinforces the assertion I’ve previously voiced that China’s leading private companies are better off listings overseas than at home. That’s because such listings in places like New York, Hong Kong and Singapore typically attract more sophisticated global investors, in sharp contrast with the mom-and-pop momentum investors that are far more typical in China.

Such retail investors have sent China’s stock markets on a roller coaster ride that saw them more than double between last fall and the first half of this year, only to give back much of those gains in a massive mid-year sell-off. US-listed names like Baidu and Alibaba also got caught up in that sell-off, showing there weren’t completely immune to the momentum buying and selling, though generally speaking their movements were less severe.

Listing in the US also inspires greater confidence in a company’s financial reports, since most New York-listed Chinese companies hire big international firms as their auditors. By comparison, Chinese-listed companies usually hire domestic accountants that are often quite happy and willing to use accounting tricks to hide losses and inflate sales.

Of course most of the 3 dozen US-listed Chinese companies that announced privatization plans earlier this year are a fraction of the size of Baidu and Alibaba, and many wouldn’t look attractive at all if they were US-based companies. So it’s no surprise that these companies are losing their attraction as “China plays” as the Chinese economy slows, and these companies are indeed probably better off listing back at home or selling themselves to larger rivals.

At the end of the day, the MSCI’s inclusion in its indexes of Baidu, Alibaba and other major private Chinese firms is a mildly positive development. I do expect shares of the companies will get a small boost in the next week or two as fund managers who follow the MSCI include the stocks in their indexes. But perhaps more importantly, this move will add a new seal of approval showing that these companies are indeed “investment grade” and not just playthings for hedge funds and other short-term investors.

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