Why is PetroChina like Facebook?

This is not a Mad Hatter's riddle that compares ravens to writing desks. It is because both PetroChina and Facebook appear to be overvalued.  

We wrote last week that Facebook's $15 billion 'valuation' was spurious, as a company's market cap and earnings outlook were not the same thing -- investors discovered this during the dotcom bubble. This overheated speculation is germane to PetroChina, whose $1 trillion price tag seems more perception than reality.

South Sea Bubble II?

The case of PetroChina recalls the 'South Sea Bubble' of 1720, the first great investment bubble of the modern age, the Wall Street Journal wrote earlier this month:

• The South Sea Company was an English company proposed in 1710, its future profits anticipated from a monopoly on English trade with the Spanish colonies of Latin America. The company was cavalier with the truth, talking up its stock by propagating extravagant rumours of the value of its potential trade in the New World. The share price rose from £128 in January 1720 to £550 at the end of May.
• Other British companies issued shares, reducing the availability of investor capital, and hampering further rises in South Sea's share price. A month later, the Bubble Act was passed, forbidding all joint-stock companies not authorised by royal charter.

South Sea is thus a good analogy for PetroChina. In both cases, restrictive government practices have effaced the notion of a market to supercharge a company's share price, which has led to a spurious overall valuation: 

• China limited its citizen investors to a tiny proportion of the overheated domestic market. Locals cannot even buy PetroChina shares in Hong Kong, where they fetch half the price. The result is an almost artificial demand within China for the shares of well-known state-owned firms.
• In its first day of mainland trading, PetroChina thus raised nearly $9 billion by selling 2.2% of its total shares to mainland investors, with the price closing at $6.52, around three times the morning's IPO price of $2.24. A few days later, the company was being spoken of as the world's largest by market capitalisation -- worth more than Exxon Mobil and General Electric combined, and roughly equivalent to the entire Brazilian economy.

Bear in mind that there is a huge disparity in the valuations of Chinese companies that have dual listings. "Notably, on November 5, PetroChina's Hong Kong shares fell 8.2% to close at $2.32, close to the company's IPO price on the mainland. Using the Hong Kong share price to calculate PetroChina's value would put total market cap at around $425 billion– less than that of Exxon or GE," writes Fortune's Asia editor, Clay Chandler.

Comparing PetroChina to operationally superior oil majors and perennial cash cows such as Exxon or GE is like comparing Facebook to more profitable, better managed and asset-richer companies such as Google and Microsoft.

PetroChina seems symbolic of the mainland market in China, where prices depart from the fundamental value of listed companies. Price/earnings (P/E) ratios stand at 64 and 73 times in Shanghai and Shenzhen respectively, compared with just 23 times in Hong Kong. Beijing may need focus on ways to discipline and stabilise its booming equity market.