China IPOSs Have Banner Year in America

By Drew Bernstein, Co-Regional Managing Partner, Marcum Bernstein & Pinchuk LLP

While China’s domestic IPO market languishes and uncertainty looms for 2019

Tencent Music’s (NYSE:TME) $1.1 billion IPO on the NYSE last week put a shiny bow on a banner year for Chinese IPOs on U.S. stock markets, with over $8 billion raised year-to-date, twice the IPO haul for Chinese companies in 2017. With 30 Chinese companies having listed on NASDAQ or NYSE it’s the best year since 2014, when Alibaba’s (NYSE:BABA) $25 billion IPO broke all previous records. What’s more, there is a sizable pipeline of China “unicorns” with multi-billion dollar private valuations hoping to score listings in the near future.

Given the deteriorating trade relations between China and the U.S., why are so many of China’s most innovative and valuable private companies still seeking to ring the opening bell in New York? And can this blistering pace of new IPOs be sustained?

China now has well over 150 “unicorn” companies with private valuations north of a billion dollars and there is a sizable network of domestic and private equity funds willing to provide a rich diet of follow-on capital to get them ready to go to market.

The love affair between Chinese tech companies and U.S. investors burns bright because each is drawn to something they are not finding at home. Investors swoon over the eye-popping revenue growth of Chinese companies and covet access to a market with users measured in billions that is not yet saturated, where new business models proliferate rapidly. Chinese founders embrace the flexibility of the U.S. capital markets, where a track record of sustained profitability is not a requirement to become public company with a rich valuation.

Most of the companies that listed in 2018 are plays on domestic China consumption with a heavy dose of innovation. E-commerce, electric vehicles, digital media, smart homes, and FinTech were all on the menu. None of them are particularly vulnerable to rising tariffs unless China’s domestic demand falters. Many of these listings were either invested in or spin outs from China’s Internet giants Alibaba and Tencent (HKG:0700), as these tech Goliaths have evolved to become private equity funds on steroids. Tencent spawned a dozen IPOs in 2018 all by itself, leveraging its WeChat ecosystem of digital services. 

Promised Land for IPOs

The dysfunction of China’s own IPO market partly explains why American remains the promised land for Chinese tech IPOs. The Shanghai stock exchange has lost 22% of its value this year, making it the worst performing major market in the world. IPOs of Chinese companies in China have raised a minuscule $2.2 billion, with only 80 companies approved to list in 2018 as of November.

China’s IPO approval process continues to favor state-owned enterprises (SOEs) and employs opaque criteria to determine which names are allowed to list. More importantly, the IPO price is guided by regulators using a modest price-to-earnings ratio, rather than set by supply and demand. While this ensures a strong trading pop and guaranteed profits for those allocated shares, it leaves a lot of money on the table for the listed company.

In the spring of 2018, China announced the launch of a China Depositary Receipt, or CDR, which was intended to lure major technology names like Alibaba, Tencent and JD.com (NADAQ:JD) to return home with a secondary listing on the Shanghai stock exchange. It is a source of no small embarrassment that the companies that best embody domestic innovation are nearly all listed overseas. The first planned CDR, Xiaomi (HK:1810), apparently had disputes over pricing with Chinese regulators and went forward with a Hong Kong-only IPO instead, and the concept seems to have been tabled for now.

In early November, President Xi Jinping announced the launch of a new stock market in Shanghai aspiring to be “China’s NASDAQ,” which will employ a disclosure-based listing system and allow innovative technology and healthcare companies to list even if they have not been historically profitable. Whether this latest effort at IPO stock market reform turns out to be successful, remains to be seen.

Hong Kong Leads in Listings, Lags in Performance

In April, the Hong Kong Stock Exchange unveiled the most dramatic changes to its listing standards in decades in an explicit bid to be more competitive against its New York arch rivals for China tech and biotech IPOs. Hong Kong was determined not to lose the “next Alibaba” to Wall Street, and now permits dual-class share structures that give management up to 10X the voting power of outside investors and will accept pre-revenue biotech companies.

The new rules have been successful in luring major new listings and Hong Kong Stock Exchange is edging out New York thus far this year, with over $31 billion raised by IPOs this year so far. But many of Hong Kong’s biggest listings, including electronics company Xiaomi and online food delivery service Meituan Dianping (HKG:3960), have been plagued by nose-diving share prices, poor disclosure, and changes in government regulation. Just a few months ago, it looked like Hong Kong was set to become the new mecca for China tech listings. But given this rocky performance, America seems to be secure for now in its perch as the best spot to tap into deep pools of institutional capital.

Read More>> Secrets to IPO Success for Chinese Company

Outlook for 2019

Will this run of new Chinese IPOs in America be sustained into 2019?

Investor appetite for IPOs normally tracks past performance, and 2018 has notched mixed results. First day returns for Chinese IPOs range from a gain of 48% for Senmiao Technology (NASDAQ:AIHS), to a 48% decline for AI company Cootek (NYSE:CTK), and an average gain of 10%. Year-to-date, Chinese IPOs have lost an average of 10% from the IPO price, which is roughly in line with average performance of all U.S. IPOs of a loss of 11%.

That said, some of the largest and mostly hotly anticipated IPOs are still to come from China, including Alibaba’s online payment subsidiary Ant Financial, which scored a $150 billion valuation in its most recent private round, and China’s answer to Uber, Didi Chuxing, which dominates the massive Chinese ride-share industry and carries a $56 billion valuation from its last round. Both of these companies have faced regulatory challenges in 2018 that caused their IPOs to be pushed back. But these sorts of mega IPOs tend to create their own momentum, and if these deals make it to market in 2019 we can expect dozens of others to be swept along on their coattails.

China now has well over 150 “unicorn” companies with private valuations north of a billion dollars and there is a sizable network of domestic and private equity funds willing to provide a rich diet of follow-on capital to get them ready to go to market.

Of course, pessimists say that a slowing economy on the mainland and escalating trade tensions with the United States will tamp down on the torrid IPO love affair. Paul Gillis, an astute observer of PRC accounting and capital markets issues, has predicted that “winter is coming” for Chinese who wish to list overseas. But it is easy to underestimate the desire and ingenuity of China’s entrepreneurs to access overseas funding, particularly as domestic credit markets tighten.

As long as there are American investors who lust for growth and Chinese companies hungry for capital who can deliver the numbers, the table appears to be set for a continued banquet.