DR roundtable: US still going strong

At a roundtable discussion in Beijing, hosted in conjunction with JPMorgan, Chinese CFOs debate the benefits of listing in the US versus elsewhere.
On September 20, while Shanghai was bracing itself for the arrival of a typhoon, in Beijing a different phenomenon was about to happen. That phenomenon was a result of much knowledge and thoughts shared by five senior officers of Chinese corporations, and six other representatives from the financial, legal and investor relations sectors, as they sat together at a table to discuss the potential and resilience of the US IPO market.

This is what the discussion, organised by FinanceAsia and JPMorgan, uncovered.

Sam Qian CFO, Buytime Media Group
Cao Qingyang, Head of investor relations department, China Life
Rene Vanguestaine, Chairman and CEO, Christensen
Cheng Li-Lan, CFO, E-House (China) Holdings
Fang Fang, China managing director and CEO, investment banking, JPMorgan
Claudine Gallagher, Global head of depositary receipts group, JPMorgan
Kenneth Tse, Asia-Pacific head of depositary receipts group, JPMorgan
Chen Leiming, Partner, Simpson Thacher & Bartlett LLP
Zhao Shuang, Lawyer, Simpson Thacher & Barlett LLP
Gordon Cheng, Executive vice-president & corporate board secretary, Vimicro Corp
Bryan Li, CFO, Yingli Green Energy Holdings

Why did your company go public, and why did you choose to list in the US?

Bryan Li: There are five points that I want to make in answering this question. The first point is that the transformation of a firm from a private company to a public company can increase the profile of the company internationally. And if the company is a big exporter, that can definitely be helpful. The second point relates to finance and sources of funds. Before the company completes its IPO, the company will have limited sources of finance. But once it becomes a public company, there will be a lot of sources for funds, both in the equity and the debt markets. The sources of funds will be

The third point relates to human capital. When a company is private, it has a limited ability to attract talent to join the company. Once it is a public company, it is easier to attract talent and grow the firm. The fourth point relates to corporate governance. A lot of Chinese private sector companies are traditionally family businesses, and the management style will reflect this. If it converts into a public company there will be an external force that leads to changes in the management style and improve the corporate governance. The last point relates to exit strategies. Early investors û such as venture capitalists û will have agreed that an IPO needs to happen so they can realise
their return.

Cheng Li-Lan: E-House is a service company that provides real estate services for developers. We didnÆt really need an IPO. We are not a capital-intensive business. In fact, my CEO kept telling me that our life would be a lot easier if we didnÆt list and just kept profitably doing our business on a modest scale. But if you want to be and remain the number one, as we are, then you need to expand geographically, expand your service scope, and invest in technology and industry expertise. That expansion needs capital. Plus, an IPO û as Bryan pointed out û takes the company to a higher level in terms of
management and corporate governance.

The real estate market in China is very fragmented. The largest developer has about 1% market share. And we, as the largest service provider, have about 1% of the market. So it is a matter of whether you are satisfied with having a modest scale business, or whether you have the aspiration to become the leading platform.

The importance of a US listing is two-fold. We were the first Chinese real estate company to list in the US. In the Hong Kong stock market there are already many Chinese real estate firms. So being the first to list in the US gave us a lot of brand recognition back home in China. It has helped us to market our brand in the Chinese real estate industry. The second point is that US investors are more receptive to growth stories and asset-light service business models. If we had gone to Hong Kong, it is very likely we would have been compared to developers, and the analysis of the growth potential of this company would not have been understood so well.

Gordon Cheng: Vimicro is the largest fabless chip design company for multimedia in China. We design chips for PCs, notebooks, cameras, and mobile phones. So as a fabless semiconductor company, going to Nasdaq added a lot of brand value, and helped us gain recognition. I remember a couple of years before we went public, we went to see Sony and they asked a lot of questions. They are now our customer, but back then they didnÆt know us. Going to Nasdaq really enhanced our brand and made us better known, and also gave us access to new capital.

Secondly, it is our goal to bring great corporate governance to Vimicro and not
just pay lip service to it, like some companies do. So we invited a couple of
very important people to join our advisory board. The first is Joseph Grundfest, the ex-SEC commissioner, who is the Stanford law professor for corporate governance. We have frequent conversations with him about corporate governance. The second person is Donald Lucas, the ex-chairman of Oracle. He is currently our audit committee chairman û a role he also held at Oracle. Our goal is to bring the highest calibre of corporate governance to a Chinese company. We still have some way to go, but the direction is very clear. Listing in the US and being subject to Sarbanes-Oxley is a big part of this.

Thirdly, it is very important to incentivise engineers at tech firms. One way to do so is through stock options. We are trying to emulate the US Silicon Valley structure and bring it to China. So that was another reason for listing on Nasdaq.

Cao Qingyang: The reasons why China Life went public in the US in 2003 are as follows. Firstly, US institutional investors are very mature. Secondly, US investors are likely to offer objective valuation. Thirdly, the US capital market has very high requirements for companies that want to list, and this led China Life to improve its corporate governance and internal controls. Thanks to this our valuation has improved in recent years.

Sam Qian: I have been through a couple of IPOs. The answers so far address common reasons why companies go public in the US. In China, status and perception are very important, and I think people also want to list in the US for status reasons.

There has been a lot of noise in recent years about the Sarbanes-Oxley act,
and its impact on listings in the US. Year-to-date we have seen 13 Chinese companies list in the US. Can you explain why Chinese firms continue to want to list in the US in spite of issues with Sarbanes-Oxley?

Bryan Li: In terms of the market size, the operational efficiency and the fund flow, the US stock market is still the largest. Secondly, although there is Sarbanes-Oxley, when we did our IPO we didnÆt treat it as a barrier. We took advantage of the act to help our company improve its corporate governance.

Also, since the implementation of Sarbanes-Oxley, the SEC has made some
concessions. A recent concession relieved some of the burdens of the act on newly listed companies for the first two years. That helped to make it less of a barrier for us.

Sam Qian: To be frank, Sarbanes-Oxley does increase costs to the company. But that is not an issue for us. In China, most successful people drive German cars, even though they are expensive to maintain. Few people complain about that, and it is the same thing with the cost of Sarbanes-Oxley.

Fang Fang: At the start there were a lot of concerns about Sarbanes-Oxley. But the push and pull factors were strong enough to keep Chinese companies listing in the US. On the push side, there is a decent population of Chinese companies listed in
the US, and that makes newcomers, as well as investors, more comfortable. There is even a valuation premium for certain types of companies. The management teams in China are also becoming more sophisticated and that makes them more comfortable and ready to go to the US.

I have also noticed a dramatic increase in the efforts of US exchanges to market themselves in China. They have always been present in China, but far less than what we see today. For example, the New York Stock Exchange had an office in Tokyo, and it would fly people into China once in a while to talk to state-owned enterprises. But the NYSEÆs marketing efforts has increased dramatically, and is not only targeting old economy companies anymore. There is a healthy competition between NYSE and Nasdaq now for listings, and they are therefore trying to provide more and more information to listing candidates.

Chen Leiming: I agree with Fang Fang. Initially there was a lot of shock when Sarbanes-Oxley was introduced. From a lawyerÆs perspective, a lot of the new regulations were considered a reaction to the prevailing mood, and frankly there was an overreaction. It put an incredible burden on foreign companies. In 2004, the number of companies looking to list in the US declined. A lot of clients we spoke to looked at alternative venues. It was challenging to encourage Chinese companies to list in the US.

Gradually, there was a change. A whole slew of technology companies found the
only way for them was to go to the US. And over the past couple of years, the situation has evolved. The SEC has made initiatives to ease and rationalise the burden for foreign companies listed in the US û and has looked at some of the more draconian requirements and tried to introduce a more practical approach.

At the same time, other markets have started to implement fairly similar corporate governance rules. So the shock factor has gradually reduced. But each company has its own objectives in selecting its listing venue and looking at which capital market to access. The companies sitting at this table all felt the US market was right for them and their companies. Not all companies will feel that.

If you ask me whether state-owned enterprises will start to think about listing in the US again, I am not sure. But in terms of the emerging companies, and privately-owned firms, I think the trend of listing in the US will continue. Another point is that a number of our clients want to use their US listing to gain an acquisition currency. For example, Suntech bought a Japanese company, and two thirds of the consideration was paid in ADSs.

Cao Qingyang: China Life has complied with the Sarbanes-Oxley act, section 404, since 2004, and put a lot of human resources into it. In the first half of 2007, we completed an internal assessment of our financial controls, and received an unqualified opinion from our independent auditor that we complied with the rules.
We have also contacted the chairman of the NYSE to get guidance on future
changes to the act. We donÆt know whether the Sarbanes-Oxley act will become more complicated or simpler. This is something that investors and companies want to know, but at this stage it is not clear what the answer is.

Rene Vanguestaine: It is difficult to predict what will happen to Sarbanes-Oxley, although a lot of forces want positive changes made to Sarbanes-Oxley û such as the exchanges and the SEC itself.

LetÆs not forget that this is a two way stream. The SEC has made it easier for companies to leave their listings in the US. A number of European companies have taken advantage of this and left the US market. But we have not seen many Asian companies do the same, and no Chinese companies. Perhaps it is because of the status and prestige, as Sam mentioned earlier.

As to the future, I see three categories of companies in China. There are the
entrepreneurial, privately-owned companies, such as in technology and media, which are typically fairly new, without a huge legacy in terms of accounts. They can move quickly and find implementation of internal controls much easier than big state-owned enterprises. To me, it is not a surprise that when you combine that with better valuations, and better understanding of certain sectors, they find it makes perfect sense to list in the US.

The state-owned enterprises were historically some of the biggest Chinese
companies to list in the US. These are huge enterprises and have huge legacy issues; they have to establish better management information and accounting systems. For them Sarbanes-Oxley is not as easy to implement, and it is not a surprise that those companies choose to list elsewhere.

The third are small Chinese companies that have gone to market through reverse
takeovers, primarily in US shells. What we have discovered is that these companies have very limited understanding of the implications of Sarbanes-Oxley.

The other dimension to this is the accounts. The SEC has recently come out
with a proposal to allow foreign companies not to reconcile to US GAAP as long as their accounts are under IFRS. This is a step in the right direction. So I continue to believe that over time we will see more companies going to the US market.
Zhao Shuang: I have an observation to make, based on my dealings with clients. Many Chinese companies are closely controlled by the founders. Under the current rules of the NYSE and Nasdaq, it is possible that these companies do not have to comply with the requirement of having a majority of independent directors. But many of them have chosen to do so, because they realise that independent directors can bring value to their company û especially strategically and for those companies that want to expand internationally. Our experience is that companies have moved from thinking that the regulations of Sarbanes-Oxley are a necessary evil, to considering them as a way to help the company beef up their internal controls, and grow in a healthier way. They realise as the company gets bigger and bigger, it also gets more complicated. So the regulations are actually helpful to them.

Rene Vanguestaine: In my view, the regulatory arbitrage is going to disappear. Only two years ago I attended a conference and heard a non-US stock exchange telling companies that the reason they should list on their exchange was that they were more lenient in terms of regulations. That did not sit well with the investors sitting in the room. Now exchanges are becoming conscious that they need to push for stronger regulatory environments in their own markets. That will ease the burden for the US exchanges û as they soften their own regulations in practical ways, the other exchanges will make theirs tougher. This will eliminate the regulatory arbitrage.

Claudine Gallagher: Overall, if we look at the regulatory environment, things are moving favourably in the US towards making the listing requirement more issuer friendly. Another encouraging US regulatory development is the easing of the requirements to deregister, that the SEC has approved more lenient exit rules for foreign private issuers, permitting deregistration based on a minimum level of US trading activity. The SECÆs proposed guidance on Section 404 û considered one of SOXÆs more stringent requirements û eliminates excessive or unnecessary evaluation procedures. Coupled with the new auditing standard on internal controls proposed by the PCAOB, the inefficiencies and unnecessary costs of Section 404 could be reduced considerably.

Sam Qian: Returning to my previous analogy, German cars are expensive to maintain and you have the option of buying a Japanese car û which might have a lower maintenance cost. This is the same thing. A lot of exchanges can approach us and say look at our cost versus that of the US. You have to think about this, and balance the benefits and the costs.

What tips the balance? Will the US relax some of the harsher rules? Will other exchanges toughen their regulations? If that occurs, then more and more issuers will go to the US. In China, people are still more inclined to list in the US because of the prestige and worry less about the higher cost.

Some people think a US listing is the gold standard, while others believe that the US has lost ground to other markets, particularly London. What do you think?

Bryan Li: I still think it is the gold standard. The extra difficulty of listing in the US can û as has been suggested û also add value to the company, by improving their practices. So I donÆt see the US as the centre of international finance changing in the near term. I donÆt see it being challenged in a substantial way by other stock exchanges.

Fang Fang: The US market has seen a relative deterioration, in the sense that it used to be the location where all global companies would list, and that is no longer absolutely the case. Relatively-speaking, the US market has lost ground to London and Hong Kong.

To me that is a positive development. Given the world is getting flatter, it is better for companies to have more choices. But the pendulum swings back and forward, and I think the pendulum is now swinging back to a better balance between an efficient capital market and an efficient regulatory regime.

Gordon Cheng: We successfully listed on Nasdaq in 2005. We would still list in the US if we were doing our IPO today. Some of the reasons for doing the IPO were customer-driven. Some of our customers appreciate the presence and recognition we get from being a US listed company.

Rene Vanguestaine: A lot of fund management firms û many originating from the US and Europe û have set up in Asia now. And that is why people say they can take care of all their financing needs by just going to a local stock exchange.

But companies should be careful. In periods of tension, capital tends to move,
and people move. Again and again, Western firms have demonstrated that when there are problems, they repatriate funds. Companies need to be aware of this. Chinese companies should resist the temptation to pull out of doing investor relations in the US and Europe, and taking the view that they can do it all locally. It is very important to continue to focus on overseas markets.
Claudine Gallager: Let me start by saying that there may be advantages going to the UK, Luxembourg and so forth. But the advantages of the US market are higher valuations, and a deep pool of capital û around $4 trillion is invested in foreign equities, which is 20% of AmericaÆs liquidity pool. Plus there is the resilience of the US market too. Year-to-date, from Asia there has been $10.9 billion raised in the US, versus $7.4 billion last year. It was $3.7 billion three years ago. Those numbers speak for themselves.

Another advantage of the US market is the enhanced credibility that often accompanies heightened transparency and governance under US law. WhatÆs more, many US institutional and retail investors are able to invest in foreign companies only through ADRs. Our role as a depositary bank is to accompany the client in their choice, and give the client all the information about where they can list, and help them to make the right choice based on their strategic needs. The US offers companies premium valuations, and the story remains positive.

As a senior officer of a US listed company, what do you think are the key
challenges that relate to operating a US listed company?

Cheng Li-Lan: I donÆt think Sarbanes-Oxley is the biggest issue, but it is a manageable process. You end up with better documentation and more transparent process, better information flow internally, and you feel more comfortable with the numbers. In my opinion, the biggest challenge is the mentality of the majority shareholder. Can they adjust their mentality to that of running a public company? Decision making, for example, needs to become a more transparent process. The majority shareholders are used to calling all the shots, and having a meeting just as a formality. So that is a cultural challenge for Chinese private sector companies. Are key decisions made by the whole board, or just by the chairman himself?

Sam Qian: The difficulty of managing a US listed company from China is that the cultures are quite different. The difficulty is translating this Chinese cultural background into the US situation, and making the foreign investors understand the problem. It is a real challenge. And it is especially
challenging for state-owned enterprises.

Cao Qingyang: I believe corporate governance is of great importance to my company. The nomination of independent directors is also a very important issue for state-owned enterprises.

What lessons have you learned from your listing, and what advice would you
pass on to other Chinese CEOs and CFOs who are thinking of listing?

Gordon Cheng: Do not just go for an IPO simply for the sake of wanting to go public. Before you go public, you need to be ready. The last thing you want is to list a company that is not ready. If the accounting is not ready and you go public, then you will have a lot of problems. Because once you go public, you will be under the microscope.

Bryan Li: Think twice, or even three or four times! You have to be mentally prepared before you go public. It is not a sprint, it is a marathon and it is an irrevocable decision. So you have to really understand the pros and cons of being a public company. Make sure you properly restructure before you list. And donÆt forget to buy insurance for yourself!

Cao Qingyang: Immediately after our IPO in the US, China Life faced a class action law suit, which is still pending a final decision. We purchased liability insurance for the directors and senior management. This is an important issue for any firm thinking of listing in the US.

Sam Qian: Listing is like a good marriage. It has many benefits but it is very costly.

Cheng Li-Lan: A successful IPO depends to a huge extent on luck. I have been CFO of three companies and only one has successfully listed. Luck and timing play a big part in whether you succeed with your IPO û whether because of market timing, or the growth cycle of your business. So many things can go wrong. The decision to pursue an IPO needs to be thought out. If it is just because the majority shareholder wants to cash-in, there are far easier ways to do it, such as selling the firm to another company or a strategic investor. If you have high aspirations to be the leader in your field, that is one of the key reasons why you would consider the IPO route.

Kenneth Tse: So based on the above and our overall discussion today it is clear that although predicting the stock market situation is impossible in this volatile market, partnering with the right depositary bank is key as so many items on the pre-IPO agenda need to be considered. You have all chosen JPMorgan as your depositary bank and we have common interests to work together to make your ADR program a success.

And as for the future of the US IPO trend, we expect to see more and more Chinese companies heading to the US market. It is because the companies will benefit from a deep pool of capital, US branding, access to the US debt market and issuance of other instruments, and an acquisition currency to pursue M&A deals. It is the quest for capital, valuation, liquidity and corporate transparency that will further drive the continuous growth of the China ADR market.
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