Check on China: The coming Taiwan boom
While everyone has their eyes on Chinese stocks, one region that should also be attracting investors’ attention is Taiwan. After a long economic malaise, the island’s stock market is set to take off. The reason: Taiwan’s political climate will soon allow its capital markets to profit from the China boom.
It would make sense that the Taiwan stock market should be booming because of its close economic ties to China. The independently ruled island is in fact one of the largest foreign investors in China with over US$150 billion invested in the mainland, and is the home to some of the world’s best hi-tech companies, such as Taiwan Semiconductor (NYSE: TSM) and United Microelectronics Corporation (NYSE: UMC), both of which have extensive operations in China. More impressive, it is one of the few countries that carry a trade surplus with China. According to official Taiwanese statistics, the island posted a trade surplus of $27 billion with China in 2006, up from $23.5 billion in 2005.
With so much going for it, the Taiwan bourse should be growing along with China’s. However, the island’s Taiwan Security Exchange Commission Weighted Index (TSEC) has a year-to-date increase of a modest 3.7% compared with a remarkable 32% year-to-date gain in the Shanghai Index. The reason for the lagging expansion in Taiwan is politics.
Taiwan President Chen Shui-bian of the island’s pro-independence Democratic Progressive Party (DPP) has tried to do almost everything he can to reduce Taiwan’s economic relationship with China. Claiming national security reasons, he sought to impose new curbs on the amount of Taiwanese investment in China (Taiwanese law currently restricts a Taiwan company’s investment on the mainland at 40% of its net worth) and even threatened to criminally prosecute Taiwanese businesspeople who violate such rules.
The result has been a loss of investor confidence in Taiwanese stocks. In fact, each time Mr. Chen pushes any measure that threatens the island’s business relationship with China or says anything related to Taiwan declaring formal independence – which equates to war with Beijing – the Taiwan stock market would drop. Meanwhile, many in the Taiwanese business community have voted with their money, leaving the island and forming new companies outside Taiwan while listing them on foreign exchanges. Approximately 50 Taiwanese firms had their initial public offerings (IPOs) in Hong Kong last year alone.
However, things are about to change, as a new president to comes to office in March 2008. The candidates from the leading parties, including Mr. Chen’s pro-independence DDP, all advocate a more business-friendly policy with Beijing. One key economic prize will be the establishment of the so-called three direct links – mail, transport and trade – between China and Taiwan. Currently, all shipping and travel between two sides must go through a third port of entry, which significantly increases costs and time delays. Mr. Chen has opposed the linkages on the same old grounds of national security.
Beijing, of course, is more than happy to oblige. The Chinese have long been pushing the three-direct links as part of their strategy of winning the hearts and minds of their Taiwanese brethren through closer economic linkages. Another big carrot from Beijing is the establishment a free trade agreement with Taipei, known officially as the Closer Economic Partnership Arrangement (CEPA), which would give exclusive rights to Taiwanese firms in their business dealings in China.
What does this all mean for small-cap investors? Taiwan’s economy and capital markets are going to take off with the election of the new president. Now is a great time to buy Taiwanese stocks before the boom happens. Giant international private equity firms have already sensed this opportunity. In the past half-year, the Carlyle Group and Macquarie Group have been snatching up a handful of Taiwanese companies. The island’s foreign direct investment (FDI) is also flooding in. The Taiwanese government reported that 2006’s FDI levels reached close to US$15 billion, a 230% increase from the previous year.
So how can small-cap investors also seize on these opportunities? Simplistically, any foreign-listed Taiwanese firm with extensive operations in China, which is the majority of the island’s companies, would be a good bet. A wiser choice is to invest in the island’s shipping and transportation firms, companies that would definitely profit from any new increased trade with China. However, many of these companies are listed only in Taiwan or other exchanges in Asia, such as Hong Kong and Singapore.
Fortunately, a good option is to buy the iShares MSCI Taiwan Index (NYSE: EWT), an exchange-traded fund (ETF) whose results mirror the Taiwan exchange. For those who are less risk adverse, take a look at Hon Hai Precision Industry (OTC: HNHPF) and Chi Mei Optoelectronics Corporation (LON: CITD).
Hon Hai Precision Industry, also known as Foxconn, is one of the world’s largest manufacturers of electronics and computer components worldwide. The company’s plants in China produce the world’s best computer products, including the Apple’s I-Mac and I-Pod, and the Sony X-Box. Founder Terry Gou, a retired military officer, is a legend in the Taiwanese business community for his disciplined management style.
Chi Mei Optoelectronics Corporation is a subsidiary of the Chi Mei Corporation, one of the world’s largest producers of plastics and rubber. Chi Mei Optoelectronics Corporation itself is a leading producer of crystal liquid displays, one of the island’s top exports to China. What makes this company particularly interesting is its founder, Shi Wen-long. Once a fervent supporter of the Taiwan President, Mr. Shi now frequently criticizes Mr. Chen’s anti-China policies in an unbridled attempt to curry Beijing’s favor. For his efforts, Beijing will definitely make sure Mr. Shi’s company will be handsomely rewarded.
With politics soon to be out of the way, the Taiwan economy and market are ready to rise on China’s economic tide. Smart small-cap investors should also catch the wave.
About the Author
Contributing author Ray Cheung has more than 10 years of extensive first-hand experience monitoring and analyzing social, political, economic and business developments in China.
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