Drew Bernstein
Ravenous appetite for new listings in 2021, if politics doesn’t spoil the party
The U.S. IPO market is off to a rollicking start in 2021, with 114 new listings in the month of January that have raised $36.1 billion. The top performer so far? RLX Technology, the Chinese e-cigarette purveyor that rocketed 146% on the first day's trading, is currently hovering at twice its offering price.
The enthusiasm for new issues will benefit from a raft of recognizable U.S. unicorns expected to come to market this year, including payments platform Stripe, kiddie gaming giant Roblox, grocery dropper Instacart, and, yes, gamified day-trading sensation, Robinhood. Call it the pandemic palooza as couch-bound investors seek riches and relief from boredom by betting on hot new stocks. The appetite for IPOs appears to outstrip the supply of investable companies. Eighty percent of the IPOs that priced in January were SPACs, that have no current operations but rather the intent to find an enticing target with which to merge.
Will China’s private companies step into the breach to take advantage of this moment?
To answer this question, I reached out to several of the most astute observers of cross-border listings to get their views on whether Chinese companies would be able to sustain the momentum of 2020 when the PRC generated 565 IPOs across its domestic and overseas stock markets.
Normal in an Abnormal World
Fraser Howie, the co-author of Red Capitalism and an authority on the historical development of China’s capital markets, said, “The IPO trends we saw in 2020 are likely to continue in China. Having recovered faster than other economies and being able to keep control on recurring outbreaks of Covid-19, China looks about as normal as you can get in a still very abnormal world.”
Howie expects that IPOs will continue to be brisk across the Shanghai STAR market, Shenzhen’s ChiNext, Hong Kong, and the U.S. for the simple reason that the private sector remains starved for capital.
“Chinese private companies need money to grow and invest; the banking sector has never been designed to address their needs, so equity financing makes sense. Equity financing is also preferable to debt financing as there is no need to pay the money back, nor, with small stakes being listed, do the founders lose control.”
Concerning listing in the U.S. market, the most significant question mark is how the incoming Biden administration will approach issues inherited from the Trump administration. These include inspecting China-based auditors by the PCAOB and a ban on U.S. investment in companies that do business with China’s military and security forces.
Paul Gillis, a professor at Peking University’s Guanghua School of Management and author of the China Accounting Blog, believes that “Trump was right to recognize the threat that China is to American dominance, but completely wrong in his approach. I think Biden will take some time restoring relationships with former allies, and then use a multilateral approach to Chinese issues.”
Outlook for a Grand Deal on Audit Issues
Gillis does not believe that the Holding Foreign Companies Accountable Act, which Trump signed into law on December 18th of 2020, will result in a mass delisting of Chinese stocks from U.S. exchanges.
“China will allow inspections, but that might be after markets reach the panic point. China will offer inspections as part of a grand deal.” And in the meantime, expect many companies to rush to market ahead of possible sanctions.
Robert Stephenson, managing director at Roth Capital, notes that institutional investors have been more cautious on Chinese names given the threat of sanctions and potential delisting. But he explains that many Chinese IPOs in recent years have not relied on U.S. funds for their success given strong sponsorship by Asian investors.
"These deals are marketed in Asia first and in some cases do not require any U.S. investor participation," he explained. "A big driver is the desire for currency diversification among Chinese investors and corporates, given the tight restriction on capital outflows.”
NASDAQ has now increased the requirement for ownership by U.S. based investors and wants to see a nexus in the business, management, and board composition to the U.S. to approve new listings. But for now, investors are eager for new growth stocks to come to market.
“2021 has started where 2020 left off, with very robust capital markets including IPOs,” said Stephenson. “Investors are not sure when it stops and will keep riding the wave. However, they all recognize there are many asset bubbles and valuations are too high.”
Frothy markets have some China skeptics ready to throw in the towel – if only for now.
“What to say? The China mania has been supplanted by the SPAC mania,” notes Anne Stevenson-Yang, whose J Capital Research churns out deeply researched reports on chicanery in China’s corporate sector. “If I recommended selling, I'm sure many would lose out on 600% gains in about 12 hours. Is this realistic or sustainable? No and no. Can it last? No one ever knows how long.”
Marc Iyeki, who advises companies on their listing strategies at Global Markets Advisory Group, believes that Chinese companies' opportunity to succeed is there if they are willing to step up to heightened expectations for transparency and compliance.
"Facing increasing regulatory and public scrutiny in the U.S., Chinese companies will need to make regulatory compliance a top priority and be able to proactively and effectively communicate with international investors, to distinguish themselves as world-class,” he said.
Healthy Pipeline of Hopefuls for 2021
Dan McClory, who has helped shepherd many smaller Chinese companies to list in the U.S. at Boustead Securities, expects new listings to be very robust in 2021. China’s rapid economic recovery from the COVID pandemic and less compelling aftermarket performance on Hong Kong's stock exchange is driving interest in a NASDAQ or NYSE listing. He notes that China accounted for 15% of all the operating companies to list in the U.S. in 2020, and he expects that to surge with a less confrontational approach by the new administration.
“Ensuring compliance with U.S. requirements for inspectable PCAOB auditors, and no PRC government or military involvement in the capital structures of Chinese companies aspiring to IPO in the U.S., will continue to be key in securing stock exchange and U.S. regulatory approvals,” McClory said.
Howie sees plenty of room for domestic and overseas markets to take part in the ongoing new listings boom from China.
“The unprecedented cancellation of the Ant Group IPO, while a huge black eye for China, has done little to dent investor interest in the market. Fintech and payment companies may need to rethink their financials and capital requirements, but since the cancellation, over $24 billion has flowed into China from overseas via China Connect,” which enables overseas investors to trade stocks listed in Shanghai or Shenzhen through the Hong Kong Stock Exchange.
“One story which cannot be forgotten from 2020 is the huge changes in access for foreign investors. Literally, any foreign institution can now apply and be registered to trade into China. This openness will underpin financial flows for years to come.”
Although there is an increasing focus on the geopolitical and moral dilemmas posed by China's rise, equity analysts are paying more attention to the financials, growth, and opportunity available in its corporate sector, Howie says. “There are tough challenges ahead, and they should not be downplayed, but it is far from clear how they impact any given deal.”
China’s corporate sector is heading into 2021 with a very well crafted “three-legged stool” as their investment thesis. They have a government that has demonstrated enormous competence and resolve in containing the pandemic that has derailed many Western economies. They have a captive market of unmatched scale and a large enough middle class to sustain domestic demand. And they have fully embraced technology and innovation as the key to China’s future and put in place the financial infrastructure to better cultivate it.
The missing fourth leg, for now, is credibility. If Chinese corporates can convince investors that their accounting and governance practices are robust, and if the government shows that capital is being allocated towards projects that create economic and social value, China could dominate new listings for many years to come.
