After a slow start to the year, the stream of Chinese companies seeking to go public through the sale of American depositary receipts (ADRs) in the US started to gather pace in the third quarter. And if the issuance keeps up, 2010 could end up being a record year in terms of the number of such IPOs. In mid-October, we brought together a group of specialists and company representatives in Beijing for a discussion about the choices available to Chinese companies wishing to list abroad and some of the issues they need to take into consideration as they start the IPO process.
Kenneth Tse, Asia-Pacific head of depositary receipts group, J.P. Morgan
Yang Diao, co-head of China corporate finance, J.P. Morgan
Wei Zhou, CFO, Charm Communications
Longgen Zhang, CFO, Jinko Solar
Robert Pu, CFO, China Nuokang Bio-Pharmaceutical
Frank Li, CFO, Standard Water
John Zhu, venture capitalist, SIG Asia Investment
Ed Job, account manager, CCG Investor Relations
Shuang Zhao, partner, Shearman & Sterling, HK
Alan Seem, partner, Shearman & Sterling, Beijing
What were the key issues you took into consideration when deciding to go the ADR route?
Wei Zhou: We are an advertising agency that primarily helps our customers to make ads and then place them on a broad spectrum of media, including TV and the internet. In the US there are other companies with business models that are similar to ours, so it is much easier for US investors than for traditional Asian investors to understand our business. The media companies listed in Hong Kong are more simple resellers. Another key reason is that we have always followed a global standard so an international listing is quite important.
Longgen Zhang: First of all, valuation. Today, domestic P/Es [in China] are higher, but whether that can last for the long term is a question. Second, if you are listing in China, the timing is not certain. You have to go through the procedures, but you also have to consider relationship issues. In Hong Kong and the US, if you follow certain procedures, you can control the timing. But most importantly, if the company’s corporate governance and business model are sound, going to the US is definitely best, because the NYSE and Nasdaq have a lot of high-quality investors that will have a positive impact on valuation.
Robert Pu: Liquidity was one of our top considerations when we considered in which market to list. We need to continuously raise capital to finance our internal R&D and in-licensing programmes in the future. Particularly, we need capital denominated in US dollars to licence drugs from the US and Europe so we can bring them into the Chinese market. It is relatively easier to raise secondary equity in the capital market in the US.
Yang Diao: In today’s environment you have a lot of consumer concept stocks getting a positive response in the US, and one of the primary reasons these issuers want to list in the US is branding. They think listing an SEC-registered company on a prestigious exchange like the NYSE or Nasdaq gives them a lot of benefits when marketing their story at home that can help them expand their consumer base.
Frank Li: While we are not a public company yet, there is a very practical reason for us to choose a certain market – the accounting principle. In our industry, US GAAP [generally accepted accounting principles] and IFRS [international financial reporting standards] are different with regard to revenue recognition which is why Chinese waste water treatment and water supply companies that have already gone public are all listed in either Hong Kong or Singapore – none of them in the US.
Longgen mentioned corporate governance, which in the US is often associated with high costs. What’s your view on this in the context of Chinese companies?
Shuang Zhao: Corporate governance and proper compliance is expensive, but I think it is very well worth it. You don’t want to fix your corporate governance when you have a class action against you, because that is really expensive. So, fixing it from the very beginning is really the right thing to do. Before going public many companies have the chairman’s relatives or someone close to the company running the books, but because of Sarbanes-Oxley they realise that they have to streamline their accounting reporting process and hire a professional CFO and other professionals in the finance department. So, Sarbanes-Oxley is a way to modernise a Chinese company. I think that aspect is really important.
Diao: US investors look at corporate governance and internal controls as a key indicator for a company’s financial strength and the robustness of its reporting system. They don’t want to see an issuer with a large number of accounting issues post-IPO or face a risk of [earnings] restatement. If you as an issuer can demonstrate really strong controls, that will give the market additional confidence that can actually help the stock performance.
When Chinese ADRs first hit New York, investors were scrambling to get a share, but today simply being a China-based company is no longer a guarantee for success. How can a Chinese company ensure it attracts the attention of US investors?
Ed Job: Over the past 20 years, the Chinese economy has been growing at double-digit rates and it is still expected to grow reasonably well in the next five to 10 years. So there is a lot of interest. But, because of some recent disappointments, and the fact that the US economy is not doing so well, investors have become more selective. There is also more to choose from, both IPOs and reverse mergers. What I see is a slight shift from growth to quality and sustainability. If investors just focus on growth, they risk investing in the wrong businesses, because despite the fact that the economy is growing, the competitive environment in China is very intensive. I think in order to address increased competition for capital, Chinese companies have to have a very strong investor relations programme to show investors how they are different, how their difference translates into a sustainable competitive advantage and that they have adequate governance and a strong management team that can navigate the competitive environment successfully.
Diao: We have done some analysis and as of the first quarter this year, about 60% of US IPOs by Chinese issuers in the past two years were trading below the IPO price. As we have gone through the financial crisis, the market has been very demanding and most companies needed a significant IPO discount. But if you look at US IPOs by Chinese issuers year-to-date, the average performance from pricing until now [early October] is 40% above the IPO price. So we think a lot of this is market sentiment-driven. But it is also a function of when you take your company public – it has to be ready.
How effective are ADRs as a listing vehicle for Chinese companies and what alternatives are there if a company wants to list in the US?
Kenneth Tse: Once you have decided to go to the US market, you can consider the ADR route, a reverse merger [also referred to as a reverse takeover], or a listing in the form of ordinary shares. ADRs have been in the market for more than 80 years and it is a proven route both from a legal and procedural perspective. They trade in the US market in a very similar fashion to US stocks, so US investors don’t need to have a different account or find a different broker in order to trade ADRs. Someone will argue that a reverse merger is a viable way as well. I fully agree. It is a matter of whether you create a new entity and bring it to the market through an IPO, or whether you inject assets into an existing listed entity in the US and then bring it to US investors through a private placement or offering. The cost of a reverse merger is definitely lower, that’s why it has become a popular route especially with smaller companies. And it is faster. But you are also inheriting a group of investors, which may not be the investors you want, and the entity itself may have other hidden liabilities that you are also inheriting.
Job: Because a reverse merger tends to be low cost, it has attracted a lot of companies that are not ready to go public and this has created a lot of bad press and a lot of problems for the Chinese segment as a whole. With media attention focusing on governance issues and the quality of some of these names, I think there is going to be a shakeup; some of these companies will be taken private, or will just wither away, and the ones that have proven to have adequate corporate governance, a quality management team and good business models, are going to trade at much higher valuations than currently.
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