Glitch and glamour of Chinese IPOs
The allure of public listings has been tarnished by offshore scandals while banks are tightening their lending, forcing CEOs of China’s most dynamic companies to look to new funding sources. Is the offshore IPO market dead?
Relaxing over coffee in SecondMarket’s central Hong Kong office, David Berger, the company’s Asia head, ponders the striking change in Chinese entrepreneurs’ attitudes that has transformed his own company’s chances in the region.
Berger, surrounded by computer screens and desks waiting to be filled, is about to dash to the airport for a flight to Shanghai. SecondMarket, a trading venue for illiquid investments, including private equity stakes, is planning to open its first mainland China office in the first quarter of next year. The company is well known in the US, but had previously not considered expansion in Asia – particularly China – because local CEOs saw raising money through a glamorous public share offering as the ultimate goal.
"Two years ago, the opportunity wasn’t here for us in China," says Berger. "Most companies were racing towards IPO; until January last year the response from potential clients would be: ‘Interesting, but no thanks’. Today, these companies aspire to list on SecondMarket and see the platform as a viable alternative to a public listing."
That, at least, is the plan. Hordes of Western financial services providers have opened offices in Asia in the past few years, hoping to benefit from the region’s growth as their home markets stagnate.
SecondMarket’s success will rely in part on how correct Berger’s thesis is: are Chinese CEOs abandoning public listings in favour of private fundraising, and will private equity investors regularly trade these holdings?
In the eyes of Chinese entrepreneurs the glitter of the IPO as a golden reward for years of hard slog has faded. A slew of accounting scandals at overseas-listed Chinese companies has dented valuations for even untainted firms. As if to confirm the notion, Muddy Waters Research, the short-selling firm responsible for the much-publicized stock collapse of Toronto-listed Sino-Forest, recently put out a new piece on Chinese company Focus Media (see What’s behind the great China stock scandals? Euromoney Spetemeber 2011. Its shares fell 66% on intra-day trading just from the report’s accusations – no matter if they are proved right or not.
Not all public listings are equal. Rupert Mitchell, head of Asia Pacific equity syndicate at Citi, says laughingly: "Don’t write us off yet" when asked if the glory days of Hong Kong IPOs for Chinese companies are over. He makes what he sees as an important distinction.
"The only reason a lot of these companies list in the US is because they can’t list in Hong Kong," he says. "You need three years’ track record of profitability, for example, in Hong Kong; many Chinese companies in the technology and media space don’t have three years of positive cashflow, let alone profits."
China’s entrepreneurs are a sociable group, and the message from those who have gone public and been disappointed has spread fast. Visiting promoters encouraging Chinese companies to list overseas touted the benefits – prestige, capital, publicity – but not the downsides: increased public scrutiny; the tyranny of quarterly reporting; and the ignominy of becoming an orphan stock.
"These entrepreneurs want to build companies that last for generations; that means they need to focus on innovation and long-term growth, not quarterly numbers or the volatility in their stock caused by high-frequency traders," says Berger.
"These entrepreneurs want to build companies that last for generations. They need to focus on innovation and long-term growth, not quarterly numbers or the volatility in their stock caused by high-frequency traders"
Berger keeps a file of cuttings of prominent Chinese chief executives speaking out against their peers’ former obsession with IPOs. It is a compelling collection: in April, three of China’s most famous entrepreneurs spoke publicly about their reservations on the rush to IPO that has seized the tech sector.
Reuters reported Robin Li, CEO of leading search engine Baidu, as saying at a company summit: "There will be a listing frenzy this year; a frenzy of Chinese internet companies wanting to list overseas. You must remember that listing is not a means to an end, it is only a means of business development."
In the same month, Forbes magazine reported Jack Ma, founder of online auction house Alibaba, as saying of the public listing process: "Who needs pressure from outsiders to expand at an unreasonable rate or to rush to profitability?"
Finally, the Oriental Morning Post reported on April 27 that Zhang Tao, CEO of social rating site Dianping, had that year shelved plans for an IPO in favour of raising funds in the private market.
The US’s Nasdaq OMX has been a favourite haunt of Chinese technology and media companies that do not manage a Hong Kong listing, but with short-sellers burrowing into the corporate governance of these companies and the entire sector underperforming US markets, it is no easy option. Not so, says Nelson Griggs, head of Asia Pacific for the exchange.
"Globally, all IPO pipelines have a backlog, but we have a good 40 or so Chinese companies that would like to go out in the US, of which the overwhelming majority are in [technology, media and telecoms]," he says. "It’s a good fit for us with the deep analyst base and good companies already here, but we are facing headwinds in getting investors comfortable with corporate governance."
Equity bankers in Hong Kong tend to agree with that prognosis, saying that the Hong Stock Exchange is unlikely to relax its stringent listing requirements and that therefore there will be room for competing overseas exchanges prepared to offer easier access to listing.
MEANWHILE, FOR PRIVATE EQUITY FUNDS SWARMING OVER China looking for the best investment targets, this change in CEO attitudes means there are more opportunities to examine. "Chinese companies wanted an IPO at all costs and they saw it as badge of honour to complete a listing," says Chris Fong, managing director at Welkin Capital in Hong Kong. "That’s less the case now. As a family office we are more interested in taking longer-term stakes in companies."
Fong’s colleague Johnny Kong says that Chinese CEOs, as well as being less interested in public listings, are attracted to the strategic advantages investors can offer: "There’s so much money around, especially now with renminbi funds opening up in China, that companies can afford to consider where the money is coming from when looking for investors."
The number of renminbi private equity funds has begun to grow quickly this year. Edward Epstein, managing partner in the Shanghai office of law firm Troutman Sanders, estimates that some 61 new funds had closed by the second quarter. That brought the volume of funds raised up 100% year on year, and that’s only the amount in formal PE funds – it doesn’t take into account the increasing popularity of informal investment clubs (see Euromoney, September 2011, Inside China’s investment clubs).
The liquidity crunch in China’s credit markets after central bank tightening policies means opportunities for the private funds sector, with the sub $100-million size of many of them matching up well with the small and medium-sized businesses being squeezed hardest.
Many of these funds do not resemble traditional private equity funds in their structure or terms.
Yibing Wu, president of Citic Private Equity, spoke on the rise of local funds in China at an Asian Venture Capital Journal panel discussion on November 10. "There’s a misperception about the amount of renminbi capital available, in that it’s a hell of a lot harder for general partners to raise renminbi than US dollars," he said. "High-net-worth individuals in China generally want their money back in two years or less, and there are invariably strange terms with the smaller funds so that it’s not really a PE fund."
The fundraising options available to Chinese companies are affected by the shake-up in the country’s buy-side institutions. The boundary between China’s fast-growing but fragmented domestic fund industry and more informal private investment is blurred.
Local governments are also setting up their own funds to attract capital, something many of them desperately need as the liquidity squeeze exposes the over-investment driven by post-2008 stimulus spending. Finally, the asset-management industry is undergoing a dramatic transformation as mutual funds face up to increased competition.
Z-Ben Advisors, a Shanghai-based research company, states in its 2012 outlook for China that "[platforms other than mutual funds] have become much more active as regulators seek to strengthen the business models of a wide variety of firms that have not traditionally been involved in asset management. Insurers, brokerages and trust platforms are all developing their own internal capabilities and will post additional competitive threats to traditional fund managers in 2012."
Meanwhile, companies big and small in China are seeing the advantages of private funding over the lengthy and expensive public equity option. Online retailing website 360buy.com is tipped to be preparing for an IPO, with equity capital markets bankers in Hong Kong privately telling Euromoney it was one of the most fiercely contested mandates of the year when pitching opened in September. The deal now looks likely to be delayed amid reported difficulties in ironing out a valuation for the company, but funding seems unlikely to be a problem.
In April, in an impressive demonstration of investor interest in the company, 360buy.com raised $1.5 billion from a group of private equity funds, including Russia’s Digital Sky Technologies. That added to the $500 million the company raised in December from a group of strategic investors, including US supermarket chain Wal-Mart.
That’s not to say that Chinese companies will stop wanting to go public. "Being chairman of a Hong Kong-listed company is still a platinum gold card for advancement for a Chinese individual," says Citi’s Mitchell. "The pipelines are essentially infinite: you have something like 150 cities of 1 million or more people, each with 20 to 30 local champion companies. The only change is that the quality of the backlog is getting better. Right now there’s only a market for great companies, not merely good ones."