American Capital Markets Dream

Chinese stocks have taken the US stock markets by storm over the last two decades and American investors have jumped on the bandwagon.

It has not all been a dream scenario for Chinese companies interested to list in the American capital markets, but all in all the stock listings experiment is a success. Despite a 2015 markets crash precipitated by concern over China’s economic performance along with the rapid depreciation of the yuan currency, not to mention a delisting binge that witnessed technology powerhouses like Shanda Interactive Entertainment Ltd., Focus Media Holding and Perfect World Co. Ltd. spend a record breaking US$5.5 billion buying back their shares, China has remained the foreign stock purchase of choice for US investors.

With over US$6.7 trillion of foreign stocks held by America’s institutional and retail investors, corporate finance teams from around the world compete to dip into the deep US capital pool. The battle between the largest and most successful companies to attract American investors extends from Latin America to the shores of Japan and the hinterlands of China. Though the usage of global capital markets is a relatively new experience for China, state-owned enterprises and entrepreneurs have embraced the Wall Street culture, with listed company American Depositary Receipts (ADRs) surpassing US$1.2 trillion in global market cap.

Alibaba Group Holding Ltd. is one company that cannot complain about its US experience. Alibaba’s 2014 New York Stock Exchange (NYSE) initial public offering (IPO) is still the world’s biggest at US$25 billion. Jack Ma’s online retailer was so popular that its stock price surged 38% on debut. This spurred underwriters to satisfy demand with an added 48 million shares sold at the IPO price of US$68. Alibaba surpassed the old US record for a Chinese IPO set by Agricultural Bank of China’s US$22.1 billion NYSE IPO in 2010. Incidentally, today the Alibaba stock rests around the US$90 mark after reaching a high of about US$120.

“Alibaba’s Jack Ma started his business in 1999 with US$60,000 from his apartment in Hangzhou,” recalls Fred Teng, President of America China Public Affairs Institute and Senior US Representative of the China-US Exchange Foundation. “I know because I met him at the Harvard Club China event in New York. He was running around collecting business models, name cards of investment bankers and building relationships. Then 15 years later he comes to the NYSE with the largest offering ever and secures 50% of China’s online e-commerce market share. If that is not the American capital markets dream then I am not sure what is.”

Alibaba was also a dream for the US financial services industry, something that peers in Hong Kong will never forget after the Hong Kong Exchange (HKE) lost the IPO to NYSE for technical reasons. The Alibaba IPO provided underwriters with US$300 million in fees, spread across 43 investment banks as 25 institutional investors accounted for 50% of the offering.

Clearly, those Chinese companies that can crack the US capital market and generate stock trading volume are pleased with the results. According to Citi’s 2016 Midyear American Depositary Receipt (ADR) Report figures, among the 2,787 ADR programs which trade in the US, four of the top ten ADR companies by trading value are Chinese listed enterprises.

Alibaba and Nasdaq-listed Baidu Inc. are the two most liquid foreign stocks, with trading value around US$139 billion and US$77 billion, respectively for the year to June 30, 2016. Alibaba’s trading activity was more than petro giants Royal Dutch Shell, BP and Petroleo Brasiliero combined.

Current stock market tech darling Inc., came fifth on the top ten list with trading value of around US$45 billion, as its IPO jumped in price from US$32 to US$45 since listing. International Ltd. (Ctrip) took ninth place. Shanghai-based Ctrip listed on Nasdaq in 2003 in a US$75 million Merrill Lynch-led offering priced at US$18 that appreciated by 86% to close at US$34. Ctrip traded at a peak of US$37.35 that day, making it the first company to double its IPO price on the first trading day.

During a difficult market environment for international companies, Chinese enterprises accounted for four of the five DR capital raisings totaling nearly US$750 million in first half 2016, most through Nasdaq-listed IPOs. Beijing-based biotech company Bei-Gene Ltd. led with a US$180 million IPO while Hutchison China MediTech Ltd. closed its IPO at US$110 million. Yintech Investment Holdings Ltd. raised US$100 million and China Online Education Group closed at around US$50 million. The market surprise was the US$1.13 billion secondary offering of Ctrip, the largest follow-on stock offering of any global enterprise.

The Other Side

When Industrial & Commercial Bank of China (ICBC) chose to list its record-breaking US$20 billion IPO in Hong Kong in 2006 rather than on the NYSE, the global financial community received a wake-up call. The world’s largest bank was sending a message that it did not need to list in the US market to attract money for its public offering. It could all be done close to home.

That is not to say that ICBC does not have respect for the power and reach of the US capital market. After all, ICBC became China’s first NYSE member firm at the end of 2013 under its broker dealer subsidiary Industrial and Commerce Bank of China Financial Services LLC. On hand for ringing the opening bell at NYSE was Bi Mingqiang, Chairman of ICBC, Joseph Spillane, CEO of the ICBC broker dealer and Sun Guoxiang, China’s Consul General.

“Becoming a member of NYSE will facilitate ICBC’s opportunity in the US, help promote the brand as well as get a deeper understanding of the US capital market,” commented ICBC in a press statement. In 2010 ICBC acquired the Prime Dealer Services division of Fortis Securities LLC, previously controlled by French BNP Paribas SA, and eventually changed the name to ICBCFS to better fit the brand to expand into the equity business.

“The reality is that Chinese companies are well received in both Hong Kong and China,” remarks Jiao Chengyue, General Manager of CMB’s New York Branch, a leading bank financier of China delistings from US stock markets. “Chinese companies came to America for many different reasons. A number of them were disappointed by the experience, the inability to explain their story to US investors and the low value applied to their business. By relisting on China and Hong Kong markets they were able to multiply their values many times.”

If the ICBC Hong Kong listing was a surprise for the financial elite, another watershed was reached in August 2016 when Tencent Holdings Ltd. overtook Alibaba to become China’s most valuable technology firm. According to BBC data, Tencent is said to be valued at US$249 billion, compared to Alibaba’s US$246 billion as of mid-August. This was due to a massive increase in profit earlier this year, largely driven by its online gaming business and advertising revenues on the Tencent platform, compared to lesser results from Alibaba and Baidu. Listed on HKE, Tencent did not seek a US listing, nor show interest to provide the financial reporting associated with it. Still, that did not stop US investors from pumping money into the tech giant.

The Early Days

The China capital markets experiment in the US extends more than two decades. Cross-cultural differences collided as successive waves of businesses listed on US stock exchanges. Growth pains were felt and hard lessons learned. These kinds of cross border listing exercises were a new development for China and over time unleashed a thriving entrepreneurial culture eager to test global waters. It was the start of a new role for Chinese companies in a global arena that promotes the role of transparency and competition.

“There were three major waves of listings that took place, and all of them were characterized by a different element, for instance state-owned listings versus private entrepreneur offerings,” recalls Ann Lee, author of What the US Can Learn from China and a former Wall Street investment banker and hedge fund manager. “Certainly China went through its growing pains in dealing with the delisting process. However, the nation’s leading enterprises have come out of this much stronger and they are ready to make another leap into global markets.”

The first wave of US listing was conducted by the blue-blood state-owned enterprise world, and the first batch headed to the NYSE between 1994 and 1998. At the time the offerings looked small, but today all these companies boast multi-billion dollar market capitalizations. One of the main watershed events took place in 1993, Sinopec Shanghai Petrochemical Co. (SPC) raised US$137.7 million in a dual NYSE-HKE listing handled by Merrill Lynch. Though this deal is small by today’s standards the IPO set SPC on a track to achieve a market cap of over US$8 billion.

One year later, Huaneng International Power Development Corp. (HIPD) launched the biggest PRC IPO ever with a US$625 million offering underwritten by Lehman Brothers, Goldman Sachs and Morgan Stanley. Today, HIPD is still listed with a market cap of around US$14.5 billion. Following close on the heels of HIPD came the important offerings for Yanzhou Coal Mining Co. Ltd., Guangshen Railways Co. Ltd.

After a lull to absorb the Asian financial crisis it was the turn of telecom and energy companies. China Mobile, the world’s largest telecom company, with a market cap surpassing US$250 billion was a precursor of things to come in 1997. When markets settled, it did not take long for China Unicom (2000) and China Telecom (2002), both large-cap companies in their own right, to follow suit. At the same time, PetroChina Co. Ltd. (market cap of US$190 billion), CNOOC Ltd. (US$53.8 billion) and China Petroleum and Chemical Corp., known as Sinopec (US$87 billion), all came to market. Smaller amounts were raised on Nasdaq’s market for second tier SOEs such as Harbin Power Equipment, Shanghai Hai Xing Shipping and Guangzhou Shipyard.

What Next?

In the early days the SOEs set the capital markets stage in tandem with the largest American investment banks. For the most part, stocks performed reasonably well and companies grew in size according to plan. It was the SOE wave that first built appetite amongst US investors eager for a piece of the rapidly emerging China Story.

The SOEs were followed by a back door listing wave that started in the early 2000s. This trend witnessed a large number of small companies enter stock markets, primarily that of Nasdaq, through the purchase of existing “shell” listed companies. The shell companies reduced the time it took for a company to list and lessened the compliance burden. While this inevitably fuelled the subsequent delisting period, back door initiatives were complex and showed that Chinese finance departments could handle such a maneuver.

Accused of accounting irregularities, 82 companies on a Bloomberg index for Chinese Reverse Mergers lost 52% of market value in June and July 2011. Severe drops in the value of US-listed Chinese companies followed. While over 60 Chinese companies listed on US exchanges from 2008 to 2011, that number dropped to just two in 2012, the heart of the delistings debacle, which saw the average PE ratio of China stocks drop to single-digit lows.

The event precipitating the delisting wave occurred in 2011, when short selling firm Muddy Waters Research accused a Chinese company listed in Canada of accounting fraud. After an investigation by the Royal Canadian Mounted Police and Ontario Securities Commission, in March 2012 Sino-Forest Corp. filed for bankruptcy protection and announced the company would be sold or restructured with the proceeds going to creditors. Chinese listed companies experienced several auditor resignations right after that and many companies came under investigation by the US Securities & Exchange Commission (SEC).

This is not to say bonafide listings of important companies did not come to market during the back door wave. Around this period tech stocks like Baidu and Netease showed investors that there were still riches in China that could be mined. These companies impressed US investors with strong management, a culture similar to that of Silicon Valley and the ability to meet the regulatory requirements of the US market without much issue.

Now, with the delistings period having run its course, we are in the third wave, one characterized by large-scale tech companies and strong interest by cash-rich Chinese companies in US mergers and acquisitions. At this point, Chinese companies and US investors seem more comfortable with one another, after both sides have climbed the learning curve and taken their losses. What lies ahead is anyone’s guess as Wall Street is an unforgiving place, where the darling of today can be the beast of tomorrow – as many a Chinese company has found out.

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