The momentum for Chinese listings in the US over the past few years has been overwhelming. An awful lot of companies went public through reverse mergers, at which a private company goes public by merging with a public shell company.
That allows firms to be exempted from some of the strenuous scrutiny associated with a conventional IPO.
However, investors and regulators alike in the US are increasingly wary with the listed companies from China after some of them were charged with fraudulent accounting practice.
Since March 2011, five Chinese companies have been delisted and a further 15 have suspended trading amidst widespread allegations of fraud. According to the US Securities and Exchange Commission (SEC), there have been 600 backdoor listings, with more than 150 being the Chinese companies since January 2007.
In the past couple of months or so, a number of Chinese companies listed in the US have suffered its Waterloo ever since the first Mainland China company had gone public in the nation. They were cross-examined and scrutinized over the credibility of their accounts and their alleged misconduct of sales of their own stocks for profit.
Domestic market analysts attribute the recent plight of the US-listed Chinese companies to the local short-sellers, who often act like detectives sniffing out problems at companies, which are banned in China, but not in the US. This time those big name institutions had targeted.
Chinese bloc. This is nothing new. The red chips are neither the first nor the last to have fallen prey to these avaricious, greenback-thirsty snipers. However, by now, the stock prices of the vast majority of scandal-ridden Chinese companies have bounced back, to some extent, to say the least. Moreover, many have regained their pre-crisis level.
Analysts nevertheless admit that the US remains an attractive capital market for the Chinese companies as its listing procedures are still comparatively convenient vis-a-vis other markets including the Chinese domestic one, in spite of the regulatory environment that turned tougher recently.
For Chinese entrepreneurs, the immense benefits of offshore IPOs, which provides a fast-track path from featureless to Forbes, are barely resistible.
Nearly ninety percent of all US-listed companies of Chinese origin are either Cayman Islands or British Virgin Islands (BVI) incorporated. Both are the world's primary offshore jurisdictions. The entity physically based in China is normally a fully owned subsidiary of the Cayman or BVI incorporated company. Under local laws, the Cayman or BVI incorporated organization is tax-exempt on income and dividends.
Because of the valuation differential that US IPOs are valued on a forward price-earnings basis whilst Chinese IPOs are valued on last year's earnings, the much higher price-earnings (P/E) ratios at IPO in China, which are normally twice the ratio in the US and Hong Kong, are superficial rather than substantial. For a fast growing Chinese company, getting 22 times this year's earnings in the US can yield more money for the company than a domestic IPO at 40 times P/E, using previous year's earnings.
Given the lengthy wait pending approval, which can take three or even more years, will the 70+ times P/E multiples now available at Shenzhen's ChiNext market stay till when you are allowed to offer?
Another offshore benefit is the different governing laws. The Cayman law, instead of the US law, is the governing law, in the case of bankruptcy of a Cayman-incorporated company that is listed in the US. If a Cayman Islands court recognizes and enforces a US court verdict in favor of the investors at the expense of the company's directors and officers whether this verdict will be recognized and enforced is unsure.
As of now, it's still difficult, if not impossible at all, for a domestically listed Chinese company to do a secondary offering. You only get one bite of the capital raising pie. In the US markets, a company can raise additional capital, or issue convertible debt, after an IPO. This factor needs to be kept very much in mind by any Chinese company that will continue to need capital even after a successful domestic IPO.
Asia Outbound held its 2011 IPO Summit at the luxurious boutique Swissotel Grand Shanghai 18 May 2011. Event sponsors discussed at sessions "the best legal and financial practices" in the IPO process for China-based companies seeking to list at such primary overseas exchanges as NYSE and NasdaQ, etc. Many of the nearly 160 participants, mainly Chinese entrepreneurs and senior managers, rigorously questioned the speakers of their specific concerns. The recent problem in accounting authenticity that ruined the credibility of the US-listed Chinese companies was one topic at the summit, furthermore, it will become a fresh field for accounts, attorneys and investment bankers to explore.
A much needed light of hope for the US-listed Chinese companies recently in trials and tribulations, is the Taomee listing and its ensuing price up. Taomee (NYSE: TAOM), a Cayman-incorporated Chinese company operating a social networking and entertainment website for children that features a virtual world, sold on 9 June 7.2 million American Depositary Shares for $9 each, raising US$ 64.7 million.
Up by 24.06% from its IPO closing price, Taomee closed at $10.21 on 10 June, the day after its IPO, whilst most Chinese companies continued to sink on the same day.
The pace of Chinese listings in the US capital market is doomed to slow down this year amid tougher regulations in response to a string of accounting scandals. Nonetheless Chinese cohorts are not scared to discontinue their endeavor for US-based IPOs, nor will the US capital market's faith in the red chips wane. The most probable imminent outcome is that companies from the Middle Kingdom evolve to be increasingly adherent to the mainstream world's rules of gaming.
