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An alternative evaluation approach is key to investing in STAR Market-listed companies

Published on August 5, 2019 by Tianyang Li

China officially launched the STAR Market1 on the Shanghai Stock Exchange (SSE) on June 13, 2019. This new board not only brings new capital to high-tech companies but also provides an important channel for private equity funds to exit2. Some private equity funds are prepared to sell their shares in the secondary market if they have held shares at least more than one year3. Meanwhile, companies associated with the National Social Security Fund are establishing new theme funds to invest in the STAR Market.

The STAR Market’s timeline

  • President Xi announces Science and Technology Innovation Board on September 5, 2018.

  • The China Securities Regulatory Commission (CSRC) publishes draft regulations for the Board on January 31, 2019.

  • China’s top securities regulator releases regulations for the Board on March 1, 2019.

  • The SSE accepts the first batch of applications for listing on the Board from nine companies on March 22, 2019.

  • China officially launches the Science and Technology Innovation Board on the SSE; the Board’s English name, STAR Market, is released on June 13, 2019.

Challenges for investors evaluating companies listed on the STAR Market

The STAR Market aims to support companies in the high-tech and strategic emerging sectors, including next-generation IT, advanced equipment, new material, new energy, energy saving and environmental protection, and biomedicine. So far, the SSE has received applications from 122 companies, of which three have submitted registered documents and 30 are expected to be part of the first batch of companies to be listed.

Evaluating the companies listed on the STAR Market is challenging for secondary-market investors considering that, as per Orient Securities, more than half of the companies’ free cash flow is negative, while a few of them have yet to report a profit. As a result, traditional metrics such as return on equity, price-earnings ratio, and discounted cash flow are not the appropriate means by which to evaluate all these companies. We, therefore, believe investors should use alternative approaches.

Of the 122 companies that have applied for listing, 68 report revenue of no more than CNY500m, while 111 report revenue of less than CNY2bn. In terms of profitability, two-thirds of the companies’ profits are less than CNY100m, with some companies even posting negative profits. Fifty-seven percent of these companies have negative free cash flow.

Most of the companies listing on the STAR Market are early-stage startups. Hence, traditional secondary-market evaluation methods would need to be enhanced to value these.

Key elements of the alternative approach

Alternative approaches mainly focus on a company’s management team, the industry’s prospects and the company’s business model.

 (i) Management team

The most important factor is the management team, which makes most of a company’s key decisions. In general, the CEO is most often one of the company’s founders. A company’s culture is defined by its founders. If a founder is competitive, the company is likely to be more aggressive. If a founder is analytical and data-driven, the company will tend to make metrics-based decisions. On the other hand, if a founder deliberates too long over decisions, the startup may have a hard time moving as fast as it should. A good management team also needs to be open to accepting personnel with different educational backgrounds and professional experience, training them and giving them opportunities to perform.

 (ii) Industry

The second factor is the industry in which a company operates. STAR Market-listed companies mainly focus on six high-tech industries. Although all these industries have substantial growth potential, their sub-industries have different competitive environments. Securities analysts could use the Porter’s Five Forces model to evaluate an industry’s upstream and downstream operations, new entrants, competitors, and substitutes. Adopting a “Blue Ocean Strategy” –essentially making the competition irrelevant by breaking out of an environment of fierce competition and creating new demand in uncontested market space – could help companies avoid excessive competition.

 (iii) Business model

Finally, a robust business model improves the likelihood of long-term profitability. Business models consist of three core parts: creating value, delivering value, and extracting value. Many classical models have helped companies achieve success. For example, the “razor and blades” business model [where one item is sold at a low price (or given away free) in order to increase sales of a complementary good, such as consumable supplies] helped Gillette to become the largest player in the global razor industry. Another example is the strategy of bundling software and hardware, which makes significant profits for Apple.

In conclusion, while traditional secondary-market evaluation methods lean toward quantitative analysis, alternative approaches tend to lean toward qualitative analysis. To evaluate a growth company, alternative approaches are both effective and necessary.

How Acuity Knowledge Partners can help with alternative approaches

With analysts across the globe, we provide valuable insights and unique analyses on companies listed on the STAR Market. In terms of alternative approaches, we use our local resources to conduct press-search research and study research reports, company filings, and cold-call feedback to analyze the target high-tech company’s management team and evaluate the industry and the company’s business model. We believe clients can use our detailed analysis and wide range of services to drive investment decisions.


1. The STAR Market, dubbed the Science and Technology Innovation Board, is a new board announced in November 2018 by China’s President Xi Jinping to encourage Chinese high-tech companies to raise funds from domestic capital markets. It is the first sub-market in China’s capital market to adopt the registration-based initial public offerings mechanism, a core system of market-oriented reforms.

2. The Main Board, SME Board, and GEM Board have profitability requirements; it is, therefore, hard for unprofitable high-tech companies to raise funds from the secondary market. The STAR Market, on the other hand, has no profitability requirements, making it easier for high-tech companies to raise funds through it. Private funds would also now have another channel through which to sell their shares.

3. The SSE’s STAR Market Listing Rules require a one-year lock-up period for shareholders; this commences after a company has successfully listed on the STAR Market. Shareholders who had bought shares of a company less than six months before the company applied for a listing would be subject to a three-year lock-up period.









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About the Author

Tianyang Li is Consulting Analyst at Acuity Knowledge Partners Beijing office. He is experienced in conducting consulting analysis of high-tech industries, including Fintech, New materials, and Biomedicine, covering macro trends, industry situations, and company research. Prior to joining Acuity Knowledge Partners, Tianyang worked in the Commercial Bank industry and has experience as an intern in Public Fund. He has strong research and risk expertise with multi-language, analytical, and operational capabilities. Tianyang holds a Bachelor of English Literature from Beijing Foreign Studies University, China, and a Master of Business Management from Hong Kong Polytechnic University.

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