Vipshop Holdings, the first Chinese company to go public in the US since August last year, dropped 15.4% in its debut on Friday, and that was after pricing its offering 23% below the indicated price range.
The final IPO price of $6.50 allowed the company to raise $72.7 million — well below the $117 million that it was targeting at the top of the range. The online discount retailer of fashion and other branded goods was marketing its American depositary shares at a price between $8.50 and $10.50 each.
A tad ambitious, seemingly, as by the end of Friday’s session, the stock had fallen to $5.50.
The poor debut suggests investors haven’t overcome concerns about Chinese companies that spread following allegations of fraud and accounting irregularities at several firms last year and don’t see sufficient upside at this point to compensate for the potential risks. Clearly this is not good news for the numerous other Chinese companies that are in the process of preparing for a US listing.
Vipshop has grown rapidly since it was started in 2008, but has yet to make a profit. And while most people agree that there is huge growth potential for online shopping in China, it is a competitive sector that has fairly low barriers to entry.
It didn’t help that the marketing of Vipshop’s IPO coincided with renewed concerns about a slowdown in China’s economic growth, while data out of the US have started to come in better than expected. Many investors have taken this as a cue to put their money into US-based companies instead.
A source said a pricing below the initial range was necessary to get investors to take the risk of buying into an unprofitable small-cap Chinese company with a short track record, which, aside from the various other concerns, is also expected to be quite illiquid. To help convince investors of Vipshop’s merits, the company’s two venture capital investors, DCM Investment Management and Sequoia Capital, agreed to buy an additional $20 million worth of shares. Their investment, which was announced towards the end of the roadshow, was viewed as positive by investors and also allowed the rest of the shares to be more tightly allocated.
About 20 to 25 investors participated in the transaction, according to a source. The demand was split about half and half between long-only investors and hedge funds. The small book and the fact that many investors decided that they simply didn’t need to get exposure to an untested Chinese company right now suggested that the people who did buy the stock were those who really wanted to own it — and who saw value at the IPO price. But the 7.7% drop immediately at open showed that was clearly not the case. After hovering around $5.75 for most of the afternoon, the share price dipped again during the final 20 minutes and finished within 10 cents of its intraday low, at $5.50.
The company sold about 11.18 million new ADS, which accounted for 22.9% of the share capital. Each ADS is equal to two common shares. The deal also comes with a 15% greenshoe that may increase the total proceeds to $84 million, although the share price will need to recover a bit if that is to be exercised.
At the IPO price of $6.50, the company was valued at about 8.7 times its projected earnings for 2013, according to a source.
Vipshop is of course not alone among internet-related companies to list before they become profitable, and many of them have gone on to become highly successful businesses in just a few years. However, there are also examples of the opposite and given the weariness about small-cap Chinese companies right now, investors are keenly aware that picking the wrong one may not just mean they miss out on big returns, but could in fact result in them losing their job. And that is a big risk to take for a $320 million market-cap company.
In addition to the other concerns, there is also a lot of uncertainty about companies using a so called variable interest entity (VIE) structure to get around China’s foreign ownership restrictions in certain sectors, including internet-based services, after suggestions last year that the government is planning to overhaul this system. While it is unclear whether any new rules, such as the need for pre-approvals will apply to VIE companies that are already listed, investors are likely to tread cautiously around them until they know for sure.
Vipshop operates in a relatively new area of the online retail market — flash sales — which means it offers high-quality branded items for sale on its website at a significant discount for a limited time. Consumers like it because they get access to brands that they might not normally be able to afford, while the brands themselves get an opportunity to monetise their inventory quickly and to attract more demand for their products.
According to a Frost & Sullivan report, the flash sales market in China is estimated to grow to Rmb107.4 billion ($16.9 billion) in 2015 from Rmb3 billion in 2010 and is expected to increase as a percentage of total retail sales as the merchandising expertise, economies of scale and the fulfilment and logistics capabilities of flash sales companies continue to improve.
The Chinese are also become more familiar with using the internet to do their shopping. The same Frost & Sullivan report noted that the number of online shoppers in China grew to 187 million in 2011 from just 80 million in 2008 and is projected to reach 363 million by 2015. Together with higher purchase volumes per shopper, this should boost online retail sales revenue to Rmb2.55 trillion in 2015 from Rmb774 billion last year.
Vipshop handled 7.2 million customer orders last year and generated $227.1 million in revenue, up from just $32.6 million in 2010. However, its net losses have also grown — to $107.3 million last year from $8.4 million in 2010.
The IPO was arranged by Deutsche Bank and Goldman Sachs.