Saturday, Jul 22, 2017, 8:54 AM CST – China

Economy

US-listed China Concept Stocks

Homecoming

US-listed Chinese companies are eager to return to China, shifting their focus to the stock market back home after a rocky romance with international investors over the past several years. Yet returning enterprises still have a long way to go before they will be prepared to woo Chinese investors

"The long process of going private – of pulling out of the stock market – is a test for my short temper,” Wu Linguang recently told NewsChina. He is the CEO of the Nasdaq-listed Jiayuan.com International Ltd., China’s largest online dating platform. The company has been seeking Chinese investors to buy out its shares since 2013 in order to turn it into a private Chinese company, the first step required to relist back in China.

The desire among US-listed Chinese companies to get out of the US stock market and court investors back home has been palpable in the past few years, particularly gaining momentum during China’s stock market boom in the first half of 2015 and continuing unabated even in the face of a sudden price slump and volatility that began mid-June. According to national newspaper China Securities Journal, about 30 US-listed Chinese companies had already received buyout offers from Chinese consortia from January to mid-August, more than any previous annual total. Nearly one-third of these announcements were made in late June, July and August. A number of other companies have also begun the process of inviting investors to take over.

This is a reversal of the dominant trend from 2003-2010, when Chinese companies flooded the US stock market, lured by an easier floating process and international investors’ enthusiasm for companies that were both operating in such promising industries as the Internet, healthcare and new energy, and based in one of the fastest-growing and biggest markets in the world. The tide began to change in late 2010, when the US’s positive image of these stocks took a turn for the worse. Enterprises looking to relist back in China felt further pushed back across the Pacific by the regulators’ promise two years ago to relax access to China’s stock market. As many of the 152 US-listed Chinese companies are leaders in their industries in China, meaning their journeys back home are highly anticipated by Chinese stock market investors, and calls for accelerating the reform necessary to realize this homecoming are growing.

Crisis of Confidence

The graphed curves of the Halter USX China Index, which follows Chinese companies listed in the US, show that the share prices of these Chinese companies did not climb as much as others did during the six-year bull market stretch in the US that started in 2009, yet they suffered more than others when the market suddenly fluctuated in late August. For example, on most of matchmaking site Jiayuan’s trading days, its share prices dipped well below their IPO level set in May 2011. The drop in share price experienced by many Chinese companies during the US stock market’s recent downturn was much deeper than the average drop of other listed enterprises.

Observers point to two main causes for what is often bemoaned as the undervaluation of these “China concept stocks” in the US. These companies are called China concept stocks because they are not only run by Chinese operators, but also are aimed at the China market. Thus, analysts say, it is difficult for foreign investors to understand a service whose users are far away from them. Jiayuan CEO Wu Linguang, for example, found it hard to explain to his US investors why it was time to offer offline services to users after working for years to earn success online. Chinese Internet companies listed overseas often run into this kind of communication roadblock, adds Wu Meng, an analyst at Beijing-based Zero2IPO Research, which focuses on China’s private equity sector.

The problem is compounded by a crisis of confidence. Most China concept stocks listed on the US stock market between 2000 and 2010, particularly those in the tech industry, received a generally warm reception. For example, William Ding, founder of Netease, one of China’s major online portals, topped Forbes’ “China Rich List” in 2003 thanks to the soaring prices of his company’s shares on the Nasdaq. Netease was overtaken by online games developer and operator Shanda in August 2004, three months after Shanda’s debut on the Nasdaq. Shares of Baidu, China’s largest search engine, closed at US$153 at the end of its opening day in August 2005, 354 percent higher than their IPO price.

However, in June 2010, US short-seller Muddy Waters accused a number of US-listed Chinese companies of accounting fraud. Share prices of these companies, whose industries range from papermaking and chip manufacturing to digital media and education, tumbled immediately, and more than 40 Chinese companies were suspended from trading or even delisted within two years. A number of others struggled to stay out of the deep end. In December 2012, the US Securities and Exchange Commission (SEC) accused a US accounting firm and the China affiliates of the Big Four accounting firms – Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers – of breaking US securities laws by refusing to provide the audit work papers of nine Chinese companies under investigation by the SEC. However, the China affiliates were prohibited from providing those papers under Chinese law.

Some Chinese companies, such as Spreadtrum Communications and New Oriental Education & Technology Group, successfully defended themselves against fraud allegations. The regulatory deadlock was eventually resolved with a cooperation agreement between Chinese and US watchdogs in May 2013. In 2014, Another wave of Chinese Internet giants entered the US stock market. Despite these events, the mutual confidence between international investors and China concept stocks had already been hit hard.

Better Back Home

While times are tough for China concept stocks in the US, returning home has become an attractive and feasible option. Besides the convenience of communicating directly with both users and investors at home, the market and regulatory environment are changing. At the end of October 2009, China launched its Nasdaq equivalent, ChiNext. The price/earnings ratio, a key indicator of stock market valuation, began to soar in 2013, with the average exceeding 100, showing that investors had strong confidence in the future profitability of companies listed on the ChiNext. Even after the drastic slump in the second half of June, its average remained high at about 70 in mid-September, compared with no more than 30 for the Nasdaq. According to a report by the Shenzhen Stock Exchange, 72 percent of the companies on the ChiNext by the end of April were in “strategic emerging industries” and 83 percent were “hi-tech” enterprises, making the ChiNext a particularly attractive environment for Nasdaq-listed Chinese companies considering going home.

The success of those who were the first to try encouraged followers. In 2013, Beijing-based online video firm Baofeng Technology decided to go public on the ChiNext, not its previous choice, Nasdaq. It listed in March 2015 with a ChiNext IPO share price of US$1.10, rocketing up to US$48 in mid-June. It plummeted to US$12 by early September, yet this was still more than 10 times its IPO price. This makes its market value much higher than its major Chinese competitors still listed in the US, making Baofeng a beacon for China concept stocks considering crossing back over the Pacific.

Previously, policy barriers impeded Chinese companies from returning home, particularly impacting those focused on Internet-related services, yet recent legislation has removed many of these obstacles. For example, a company currently has to report a certain annual net profit before applying for the float. Even if it is fully eligible, it still needs to undergo a lengthy review process. Internet companies then have to rely on foreign venture capital to feed their growth in the early stages. At the same time, foreign-held companies have no access to either the licenses required to provide Internet services in China, or the Chinese stock market. A typical, mutually beneficial arrangement is foreign investors supporting a Chinese Internet company in exchange for access to the Chinese market. The Chinese operation, controlled by Chinese citizens, agrees to transfer profits to foreign shareholders as technical or financial service fees.

In early June, the State Council lifted the restrictions on foreign shareholding in e-commerce operations in China to encourage “businesses with a special shareholding structure” to relist back home. This will make it possible for e-commerce providers like Alibaba or Vipshop to return without restructuring. At the same time, Chinese companies with this special shareholding structure are in fact defined as “foreign-funded” under the draft of the Foreign Investment Law released earlier this year, and thus will face the risk of having their licenses revoked. If the company wanted to delist in the US and relist in China, it would have to restructure its shareholding structure to make it a fully Chinese-held company.

Moreover, China’s Securities Law is under revision, and relaxed reviewing and profitability requirements for all companies are expected to be the biggest change. All of these factors, as Zero2IPO analyst Wu Meng told NewsChina, have acted as both carrot and stick, giving Chinese companies listed overseas both incentives and pressure to consider revising their “foreign-funded” structures.

Apart from this, new options for companies to raise money in the early stages of development have either already become available or are on the agenda in China. The National Equities Exchange and Quotations, a new exchange to trade shares of non-public, small-scale hi-tech companies for institutional and wealthy investors, was launched in late 2012 and has been growing rapidly due to its easy accessibility. By the end of August, 3,359 companies had been traded there, a figure 80 percent greater than the number of companies that had been traded by January and more than the total number of public companies in China.

At a forum in May, Liu Shi’an, deputy general manager of the Shanghai Securities Exchange, stressed that a new board was in the works, specifically to cater to the needs of the growing interest of tech-focused China concept stocks in going home. This concept of a so-called “board for strategic emerging industries,” which include the Internet, new energy and biotech, was endorsed by the State Council in June.

Challenging Courtship

The recent stock market dive and ongoing fluctuations in China have not deterred China concept stocks from setting their sights on returning home. These companies can use this period to do due diligence, which may take several years, explained Liu Gang, an analyst with the China International Capital Corporation (CICC), a China-foreign joint venture investment bank. Each step down the road is fraught with challenges and uncertainties, noted Liu. Most China concept stocks are still going through the first step, buying stocks from foreign shareholders to get delisted from US or other overseas markets. “It is a game of interest between Chinese and foreign investors,” he said to NewsChina.

Half a year after its Nasdaq debut in December 2014, Chinese social networking site Momo received a privatization offer from a consortium led by its co-founder Tang Yan. On the same day, US law firm Levi & Korsinsky, LLP launched an investigation into the fairness of the deal. It claimed that the stock price of the company once peaked at $19.11 per share, higher than the US$18.90 proposal. The law firm is collecting responses from investors in the US to prepare for legal action. Also on that date, the SEC filed a lawsuit at a New York court against Chinese national Luo Haijian for insider trading prior to the privatization offer of NYSE-listed Qihoo 360 Technology, a major Chinese Internet security company.

Companies not focused on e-commerce still have to go through this shareholding structure reshuffling to keep their business licenses and to list in China. “It is completely normal for buyout price negotiations with foreign investors to take two to three years,” Wu Meng told NewsChina.

The path in China is not easy, either. So far only one out of the 20 or so companies that have already delisted from overseas markets, mainly in the US, have successfully relisted in China.

According to Liu Gang, there are three ways to go public in China after quitting overseas markets: acquire or be acquired by a company already listed in China, make an IPO or wait for the new board for strategic emerging industries to be established.

Each choice takes time and has its own risks. It is not easy to find an appropriate listed company to act as a shell. For instance, digital media company Focus Media exited the Nasdaq in May 2013. It was not until early June of this year that its detailed scheme of partnering with shell company Jiangsu Hongda New Material came out of the woodwork. Two weeks later, Hongda’s chairman was submitted to a probe by the China Securities Regulatory Commission (CSRC) for irregularities in information disclosure. On August 31, the two enterprises’ short marriage came to an end. Although Focus immediately found a new love interest in Guangzhou-based Hedy Holdings, the long and dramatic story has been used by analysts as an alarming lesson on the importance of choosing a proper shell, as potential shells are normally badly performing stocks.

In early July, regulators suspended all IPOs in China as part of the government’s intervention that aimed to stabilize the market. No one knows when IPOs will be allowed to resume, let alone what possible reforms may be imposed on the IPO system itself. There is also no timetable for the launch of the board for strategic emerging industries. The National Equities and Exchange Quotations has become the only realistic option for companies looking to relist. However, it is difficult to make such a drastic change, giving up the open market to move to a much smaller, over-the-counter version that is limited to certain investors.

For Chinese retail investors dominating the stock market in China, the surge of Chinese companies coming home could mean both more opportunities and more risks. While China concept stocks may have been undervalued on the overseas markets, they could be overvalued on their home turf. It is widely agreed now that the biggest bubble that caused this summer’s China stock market chaos was from the ChiNext. Before the bubble burst, any analyst questioning the rationale of the ChiNext’s crazy rise had been mocked as being behind the tech-oriented times. However, in the end, profit reports rule. When investors suddenly realized many miraculous growth stories touted by these companies would never come to fruition, prices nosedived.

Many China concept stocks are leading players in their industries, with much stronger incentives to provide misleading growth stories, as well as the ability to do so. However, the scrutiny needed to secure proper information disclosure in China remains weak. There is growing impatience among Chinese investors towards regulators’ insufficient progress on cracking down on the accounting fraud of listed companies. The market force is simply absent. In the US, the firm Levi & Korsinsky alone, for example, has launched several legal actions against, or investigations into, US-listed Chinese companies because of misleading statements of their business operations which have caused losses for investors overseas. Whether investors win these cases or not, the legal pressure serves as a precaution. With no access to such legal action, however, Chinese investors have no means to recoup their losses caused by corporate misconduct, giving some reason to doubt these China concept stocks will behave well when they are back home and whether they will fulfill Chinese investors’ high expectations of improving the domestic stock market.

Both China concept stocks and China’s stock market itself will need to go through a lot of preparations before they’re ready for a happy courtship.

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