Sunday, December 09, 2007

Chinese IPOs: Discuss

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Chinese companies’ listing debuts are a vital force in the current global IPO marketplace. According to a December 8, 2007 Wall Street Journal chart (here), 195 Chinese companies listed their shares through November, raising $87.3 billion – representing a 26.7% share of the 2007 global IPO volume. By contrast, the IPOs of 174 U.S. domiciled companies raised $38.5 billion, which represents an 11.8% share. In addition, according to a December 3, 2007 Wall Street Journal article entitled "Chinese Firms Will Test Market Appetite for IPOs" (here), "December could see the launch of three issues that, in total, might eventually raise more than $12 billion." By years’ end, the amount raised in 2007 by Chinese company IPOs could well exceed $100 billion.

Stock exchanges around the world are jockeying for a piece of this action. A December 3, 2007 Financial Times article entitled "Markets Jostle to be China’s IPO Buddy" (here) notes that "Singapore and Hong Kong are falling all over themselves to be the destination of choice for capital hungry mainland companies, while smaller Chinese companies are still attracted to the perceived lighter-touch regulation of London’s Alternative Investment Market." By the same token, the three anticipated December offerings mentioned above are all scheduled to take place in Hong Kong or Shanghai – not in New York.

In order to try to increase its share of this business, on December 3, Nasdaq opened a Beijing office. The Financial Times article, commenting on the office opening, snipes that the U.S. exchanges "face steep challenges, including the time zone and worries about the country’s litigious environment." (More about what the litigious environment has meant for Chinese companies below.) But the biggest challenge for the U.S. exchanges is that "Asia is so awash with liquidity that issuers rarely need to look beyond Hong Kong."

For all that, in 2007, Nasdaq still managed to increase the number of its Chinese listings. According to a December 3, 2007 Wall Street Journal article about the Nasdaq Beijing office opening (here), as of the end of November Nasdaq had 52 listed mainland Chinese companies, with a combined market capitalization of $57 billion, up from 33 Chinese firms with a total capitalization of $25 billion at the end of 2006. The 19 listings by Chinese companies this year are "more than double last year’s total of nine."

Give the ample liquidity available in Asian financial markets, it is worth asking why Chinese companies would nevertheless be willing to confront U.S regulatory requirements, litigiousness, and time zone differences to list their shares in New York. According to a May 10, 2007 Financial Times article entitled "New York Proves an Attractive Destination" (here), the large privatized Chinese enterprises are attracted to Hong Kong, but maturing small venture-capital backed companies are attracted to New York because "they can still get better valuations and wider analyst coverage in [the high tech and life sciences] sectors than in the resurgent Chinese domestic markets or in the other parts of the world.’ One source is quoted in the article as saying that a New York listing helps the companies to establish their brand internationally, for which "nothing matches a U.S. listing."

But before we break out the champagne to celebrate Nasdaq’s success in attracting more Chinese companies’ offerings in 2007, it is worth taking a look at what the increased number of Chinese listings has actually wrought. Even a quick look suggests that just because a Chinese company is eager to list its shares does not necessarily mean that the company is ready for the scrutiny that comes with a U.S. listing. Indeed, a more detailed analysis confirms that some of the Chinese companies that have listed their shares on U.S. exchanges may not have been ready for the burdens and responsibilities, to their investors’ disappointment.

The most telling fact is that of the roughly 165 companies that have been sued in securities class action lawsuits in 2007, seven are Chinese companies. Even more significantly, of those seven companies, five completed their IPOs less than 12 months prior to the initial lawsuit filing – including one, Giant Interactive, that debuted on November 1, 2007 and was first sued on November 26. A sixth company, Focus Media Holdings, which was first sued on November 27, 2007, had just completed a secondary offering on November 7, 2007.

A review of the allegations of the lawsuits against the seven companies reinforces the view that at least some of these Chinese companies that the U.S exchanges succeeded in attracting to New York may not have been ready for prime time.

Here is a brief summary of the allegations against the seven companies:

Xinhua Finance Media (first sued on May 22, 2007, refer here): The plaintiffs allege that the Prospectus issued in connection with the company’s March 8, 2007 IPO failed to disclose that the company’s CFO at the time of the offering was simultaneously an investment banker in charge of a securities firm that is the subject of an SEC investigation, and that he was also an investor in two companies that had been sued by the SEC for fraud.

Qiao Xing Universal Telephone (first sued on August 9, 2007, refer here): The lawsuit arises out of the company’s restatement of its financials for the years 2003, 2004 and 2005. The company stated at the time that misstatements resulted from deficiencies in the company’s internal controls over financial reporting.

China Sunergy Company Limited (first sued on September 10, 2007, refer here): The lawsuit alleges that the company’s Prospectus in connection with its May 17, 2007 IPO failed to disclose that the company was having difficulty obtaining a sufficient supply of polysilicon, which forseeably would have a near-term impact on earnings.

LDK Solar Company (first sued on October 9, 2007, refer here): The company was sued after the company’s financial controller resigned, reporting to the SEC and the company’s external auditor that the company lacked internal controls and that the company’s reported polysilicon inventory was 25% overstated.

Fuwei Film (Holdings) Company (first sued on November 19, 2007, refer here): The lawsuit alleges that the Prospectus in connection with the company’s December 19, 2006 offering failed to disclose that the company’s main operating assets were obtained through transactions that may not have been valid under Chinese law. On October 15, 2007, three of the company’s major shareholders, including one director, were arrested on suspicion of legal violations.

Giant Interactive Group (first sued on November 26, 2007, refer here): The lawsuit alleges that the Prospectus released in connection with the company’s November 1, 2007 IPO failed to disclose that the company had experienced a third-quarter 2007 decline in users (i.e., prior to the offering), which it disclosed for the first time on November 19 (less than 3 weeks after the offering).

Focus Media Holding (first sued on November 27, 2007, refer here): The lawsuit alleges that the company’s Prospectus in connection with its November 7, 2007 secondary offering failed to disclose that acquisitions in its Internet advertising division were depressing the division’s gross margins. In the company’s November 19 earning release, it disclosed that its gross margins had declined due to several recent acquisitions.

To be sure, there is nothing uniquely Chinese about these kinds of allegations (except perhaps with respect to the Fuwei Film allegations). But it is the frequency of these allegations relative to the number of listings that is disturbing. Five of these seven companies are listed on Nasdaq (LDK Solar and Giant Interactive are NYSE listed), meaning that these five represent roughly ten percent of the 52 Nasdaq listed Chinese companies. Moreover, four of the seven are among the 19 Chinese companies that debuted on Nasdaq in 2007 – representing roughly 21% of all Chinese companies that listed on Nasdaq this year.

If the U.S. exchanges' "success" means only that they have attracted companies that stumble out of the blocks, investors may soon lose their sinophilia. This process may already be taking place. A December 7, 2007 Wall Street Journal article entitled "China IPOs Lose Some Allure" (here) noted that two Chinese companies, WSP Holding and VisionChina Media, had to cut their prices to sell shares in their December 6 offerings.

All of this could be interpreted to suggest that in the U.S exchanges’ haste to woo Chinese listings, they may be attracting companies that are not prepared for everything that goes with a U.S. listing. U.S toy retailers learned the hard way that consumers expect to be protected from toys with lead-based paint. The U.S exchanges shouldn’t have to learn this same lesson all over again in the financial marketplace. The measure of the U.S exchanges’ "success" in the global IPO marketplace should not be based on quantity, but on quality, in order for the U.S markets to maintain their reputation for transparency and integrity and to continue to offer superior valuations for companies that can, in fact, withstand the scrutiny. For the sake of the competitiveness of the U.S financial markets, the U.S exchanges themselves must take steps to ensure that foreign issuers continue to perceive that "nothing matches a U.S. listing."

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