Dear Fellow Investor,

In case you haven't heard all of the hype, the Industrial and Commercial Bank of China begins trading publicly tomorrow in the largest initial public offering (IPO) in the history of the world. It has already raised a whopping $22 billion, and tomorrow's trading debut is quite the buzz in China.

As investors profiting from China's historic growth, what should we make of this high-profile event?

I'd like to share my analysis with you in this week's Dispatch and tell you about a couple of other recent IPOs flying under Wall Street's radar that I believe are much better opportunities.

What's All the Buzz About?

First, it's extremely important to note that ICBC is not listed on the U.S. exchanges, only in Hong Kong and Shanghai. That means it is not easily available to individual investors who don't live in China. The good news is that it is getting easier for U.S. investors to buy stocks traded in global markets—including China and Hong Kong—and I expect us to use this to our advantage down the road. For now, though, you're almost always better off sticking with stocks traded on U.S. exchanges.

However, even if ICBC were traded in the U.S., I would not recommend you buy it. This brings me to my second thought: Only a year ago, the state of China's banking system was perhaps the biggest single systematic risk for investors. Now, a Chinese bank is the biggest IPO in history, and it follows other successful Chinese bank IPOs.

So what happened? And if investing in Chinese banks isn't the way to go, then what is?

To answer the first question, we need to take a step back. Chinese banks were created as state-owned enterprises (SOEs) to act as financing arms of the government, not as lending institutions trying to make a profit. This had a significant impact on the way they were run. For example, up until recently the government would put its own people in management roles for political purposes, not because they knew how to run a bank. There was a severe lack of management expertise and lending experience, not to mention widespread corruption.

For these reasons, the Big Four Chinese banks, led by ICBC, racked up a huge amount of bad loans. Although ICBC is the largest bank in China in terms of assets, it ranks third among the Big Four in terms of bad debt. It is not as well regarded as the Bank of China and CCB, the other two giant banks that went public in Hong Kong during the past year. It is however, far superior to the problematic China Agricultural Bank.

In recent years, the Beijing government has used two main strategies to transform its banks: injecting massive amounts of funding and eliminating bad debt. Since 1998, Beijing has pumped $95 billion into the Big Four state-owned banks to improve their capital structure. At the same time, the government transferred over $300 billion in bad debt into four newly created asset management companies. The funds used to bail out the banks came mainly from China's huge foreign reserve, which is the biggest in the world.

In the end, the Chinese government won big and managed to recoup most of the capital it infused into problematic banks through the huge dollar amounts raised in the recent IPOs.

Raking in the Windfall Profits

By shoring up bank balance sheets with government funds, Beijing has made its banks far more attractive to foreign banks and other strategic investors. That's especially important right now because when China joined the World Trade Organization in 2002, part of the agreement was that foreign banks would be allowed to enter the Chinese market at the end of this year.

As with other businesses, international banks are eager to profit from China's growing economy and increasingly affluent population. The quickest way to do that is to partner with existing Chinese banks and use their retail branch network for product distribution. At the same time, Chinese banks look to their international brethren for additional capital, technical expertise and better risk-management practices.

I believe China's banking reform and foreign banks entering the picture at the end of this year are good news for us as investors. I don't recommend you invest directly in a Chinese bank right away, and I don't yet see any international banks whose businesses will be revolutionized by their presence in China. But those opportunities could come, and I'll let you know right away if they do.

The more immediate impact I see for the stocks I'm recommending in China Strategy is the likelihood that international banks will vastly expand the number of credit cards in China. (Click here to join China Strategy today at discounted prices and get immediate access to all of my current recommendations.)

Very few people in China have credit cards at the moment, but that's beginning to change thanks to the emerging middle class. Banks like Citibank and Bank of America have the marketing, operational and technical expertise to accelerate this process, and more credit cards in China means more spending—and faster growth for our companies.

For example, you can see how bookings at our online travel company could increase with more credits cards in use. Or how more online gamers would pay for computer time at an Internet café to play our online gaming company's latest blockbuster hit. More people would eat at restaurants owned by our recommended company, or download the latest value-added services from our wireless provider. I could go on and on.

Our stocks are already benefiting from China's rapid growth, but the rush of foreign banks to get into China in the next few months could have a nice windfall effect for us as credit card marketing and use increases. I'll be sure to keep you posted and let you know if there are any direct investment plays that arise as a result. In the meantime, there are a couple of other recent IPOs traded here in the U.S. that are much better opportunities.

Two IPOs You Should Invest In 

While Wall Street and the world are busy watching the Industrial and Commercial Bank of China, two other Chinese companies have recently gone public here in the United States to much less fanfare. I believe now is the time to get in before everyone else catches on, and that's why I'm just now recommending them to my China Strategy readers.

The first is now my top pick for profiting from the China Miracle. This stock has it all: great earnings growth, high profit margins, a large and rapidly growing end market, favorable government relations, fast-growing penetration into a giant global market, top-tier institutional sponsorship, reasonable valuation, tremendous international growth and a dominant industry position within China itself.

The second is a great way to profit from China's booming education sector, which is growing even faster than its economy as a whole—and we already know how red-hot China's overall growth is. The company recently posted a whopping 101% increase in profits over last year as revenues rose 31%. It's hard to find that kind of growth in the U.S. anymore, which is why I believe the next Microsoft will come out of an emerging market like China.

I'll be releasing my full reports on these two stocks to my China Strategy subscribers next week. I invite you to join us today and be among the very first to act on these newly discovered gems. Click here to learn more.

Sincerely,

Robert Hsu
Editor, China Strategy

P.S. With the markets on a tear, our China Strategy stocks are doing spectacularly well. In the last four months, our current recommendations are up an average of 19%, with three stocks up more than 40% in that time. Click here to get in on the profits today.