what it means for investors, start-ups
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Traders are working during Didi Global Inc’s IPO on the New York Stock Exchange floor, New York City (USA), June 30, 2021.
Brendan McDermid | Reuters
BEIJING — Investors may have to think twice about whether to bet on Chinese tech start-ups as new regulations are imposed on mainland companies looking to go public in the U.S.
Fund managers may need to reconsider their investment strategy if Hong Kong listing becomes an option. There are differences in how New York’s stock exchanges deal with initial public offerings.
Both China and America have made it easier for Chinese businesses to do business in New York since the summer.
This affects more than just investors. Analysts said that Chinese companies seeking capital raises face more uncertainty regarding their ability to list on the stock market and may also experience lower valuations.
Beijing’s moves have far more dire consequences. Officially, the Cyberspace Administration of China, which is becoming increasingly powerful, will require a formal application starting Feb. 15. data security reviews for certain companies before they are allowed to list abroad.
The new regulations may mean similar IPOs will be required to Hong Kong in future, despite the technical details of how Chinese companies worked with institutional investors in order to list in the U.S.
For tech companies, that could mean lower valuations than if they listed in New York, said Richard Chen, managing director with Alvarez & Marsal’s Transaction Advisory Group in Asia.
He stated that a Silicon Valley-based market could place higher prices on the potential growth of a tech firm’s business than Hong Kong, which has greater emphasis on profitability and is familiar with models for businesses operating in physical stores and fields like precision engineering.
With new Chinese regulations, Chen said his clients — mostly traditional private equity firms — are looking more at traditional industrial companies and businesses that sell to other businesses, or sell to consumers without relying much on technology.
Our clients have been asking themselves: “Does it make sense for us to examine those industries if it becomes a problem to list in America given all the regulatory concerns?” Chen stated. The Hong Kong listing had a lower value, so clients might need to reconsider their investment strategy.
Investors: What does it mean?
Faced with the potential of lower returns — or inability to exit investments within a predictable timeframe — many investors in China are holding off on new bets. This is if the investors can raise enough money to start with.
Preqin Pro’s data shows a dramatic drop in crowdfunding by U.S. Dollar-denominated, and yuan -denominated China venture capital and private investment funds during the third quarter and fourth quarters in 2021.
For U.S. dollar funds focused on early-stage Chinese start-ups, annual fundraising since the pandemic started in 2020 has fallen below $1 billion a year — that’s down from $2.43 billion in 2019 and $5.13 billion in 2018, according to Preqin.
Start-ups might be seeking support but U.S.-dollar-denominated Chinese funds have been sitting on capital. A measure of undeployed funds, known as dry powder, reached $45 billion in June 2021 — the highest level for at least 10 years, according to the latest Preqin data.
According to CNBC’s translation, Ming Liao (founder partner at Beijing-based Prospect Avenue Capital) stated that “Due to uncertainty about exiting, we have slowed down our pace of investment” in Mandarin. According to CNBC translations, Ming Liao said that the firm was worth $500 million and expected to be able list its investments in the U.S. this year.
Liao stated that the U.S. was the most viable exit route for Chinese technology and internet companies. There’s high acceptance for new models, high tolerance for nonprofitability and very high liquidity.
A China Renaissance report released earlier in the month stated that the last year’s average daily turnover in stocks in Hong Kong was approximately 5.4%. This is an indicator of liquidity.
Large Chinese corporations like Alibaba JD.comThe report stated that their Hong Kong-traded share turnover averaged between 20% to 30% of New York’s. According to the analysts, secondary Hong Kong listing of U.S. listed Chinese companies is usually priced lower than those in New York.
Chinese IPOs in the U.S. were headed for a record year in 2021, until Chinese ride-hailing company Didi‘s listing in late June on the New York Stock Exchange drew Beijing’s attention. Within days, China’s cybersecurity regulator ordered Didi to suspend new user registrations and remove its app from app stores.
This revelation revealed how high-stakes compliance is within China for Chinese companies and was the start of a revamp of overseas IPO processes.
Among many measures, China Securities Regulatory Commission published new draft rules for December. These regulations set out the requirements to file for a listing overseas and stated that the commission would reply within 20 days after receiving the materials. According to the commission ended the public comment period on Jan. 23, without revealing an implementation date.
The uncertainty we see will dampen investor mood, possibly depress Chinese IPO valuations in the US, and make it difficult for Chinese companies overseas to raise capital.
Li Yang (chairman of the government-backed think Tank National Institution for Finance and Development) said last week that China’s new draft rules for Chinese IPOs offshore would align the country with international institutional investing standards.
The U.S. Securities and Exchange Commission demanded more information from Chinese companies about their regulatory risk and links to government backers in December. White House sanction on Chinese companies such as SenseTime briefly disrupted IPO plans.
Foreign financial institutions involved with Chinese IPOs face rising “commercial risks” of the invested company “becoming sanctioned because of its reputation with the U.S. government,” Nick Turner, a Hong Kong-based of counsel with law firm Steptoe & Johnson. It is important to focus on this area during the due diligence before an IPO.
This is what it means to start-ups that are looking for a listing
Even if the market is favorable, it remains unclear how to go about an IPO in Greater China.
Analysts stated that Chinese companies seeking to be listed overseas will likely need more information from both the Chinese and American regulators. They may also expect to have their applications reviewed by different authorities and agencies.
Analysts stated that the new rules could result in long wait periods for foreign companies looking to list. This uncertainty could dampen investor mood, possibly depress valuations of Chinese IPOs in US, and make it more difficult to raise funds from overseas for Chinese businesses.
After the high-profile suspension of Alibaba-affiliate Ant’s planned IPO in Hong Kong and Shanghai in late 2020, authorities also delayed the public listing of computer manufacturer Lenovo and Swiss seed company Syngenta on the mainland last year.
The Hong Kong exchange website reports that more than 140 companies have filed active Hong Kong IPO filings. EY reported that the number of Hong Kong companies still wishing to be public on the mainland and Hong Kong was above 960 at the close of 2021. This is little different from the June report, which had been subject to the most recent regulatory scrutiny.
On the pre-IPO end, 12 Chinese companies joined the list of new unicorns — private companies valued at $1 billion or more — in the second half of last year, according to CB Insights. India, however, added 26 unicorns while the United States gained 148.
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