Despite a directive from a White House working group that could lead the SEC to close the door to companies whose auditors are not PCAOB-inspected, Chinese companies continued to raise significant amounts of capital on U.S. exchanges in the third quarter of 2020.
In what was generally a scorching market for new issues, 11 new Chinese companies went public in Q3 on NASDAQ and the NYSE, raising $5.9 billion, up by 350% from the $1.3 billion raised in the same period last year, according to data from Renaissance Capital. Chinese names returned 14% to investors in Q3, versus a loss of 49% for the Chinese companies that debuted in Q3 2019. These gains continued to lag the overall IPO market, which was up 38.1%. However, looking at Chinese deals that raised over $100 million, the average returns were 67%, handily outperforming the market. While U.S. investors remain selective, demand remains robust for companies with the right pedigree and growth characteristics, enabling several deals to price at the top of their indicated range.
For the first three quarters of 2020, Chinese listings have already exceeded last year’s totals, with 30 IPOs raising $8.5 billion, versus 28 listings and $3.6 billion raised in 2019. Average returns were a positive 15% as of October 2, 2020, compared to a negative 17% for all Chinese IPOs in 2019.
Goldman Sachs, Credit Suisse, Citi, and Morgan Stanley are in a dead heat helming China names among investment banks, each taking the “lead left” position on three IPOs so far in 2020. Investment banks based out of China and Hong Kong have become increasingly active managing U.S. IPOs, with firms including CICC, China Renaissance, AMTD, Haitong, and Tiger Brokers participating in multiple deals. In many of these IPOs, Asia-based investors continue to make sizable advance commitments to provide the market with confidence that bankers can fill the order book. Skadden Arps continued to dominate as corporate counsel this year, providing legal advice to seven Chinese IPOs, followed by Davis Polk and Ellenoff Grossman, with four deals apiece.
Despite the improved performance of this year’s listings in America, there has been an explosion of Chinese companies going public in Shanghai and Hong Kong. Shanghai ranked #1 among global exchanges at the end of the third quarter, with $38.2 billion in IPO proceeds. Hong Kong ranked #3 behind NASDAQ with $23.4 billion, bolstered by several “secondary IPOs” by well-known U.S.-China stocks, including Alibaba, JD.com, Netease, and Yum China. The infusion of large-cap technology names, along with several biotechnology IPOs, has changed the Hong Kong market's traditional weighting towards old economy banking, real estate, and consumer stocks. The launch of the STAR market in 2019, which provides unprofitable advanced technology companies with a fast-track listing process and allows IPO pricing determined by market forces, has transformed Shanghai's profile as the home to large SOEs from traditional industries.
Investors and companies will be watching carefully as Ant Group launches what could be a record-shattering $35 billion simultaneous IPO on the Shanghai and Hong Kong Stock markets slated to close later in October. If successful, the listing will be a dramatic demonstration of China's stock markets' depth and liquidity and provide a template that other mega-caps from China may wish to emulate. A dual-IPO strategy offers the ability to tap enthusiastic domestic Chinese retail investors willing to bid up the valuation, while simultaneously accessing international institutions and dollar-denominated funding through the Hong Kong offering. For companies that enjoy strong government support, this might be the best of both worlds.
It is unclear if the loss of the Ant Group IPO will cause American regulators to reform the listing standards for Chinese companies in a way that maintains the competitiveness of U.S. exchanges or if it will hasten the retreat of China’s tech giants from U.S. markets.
While there has been a convergence in IPO listing standards on both sides of the Pacific, the U.S. continues to provide the greatest flexibility in raising subsequent rounds of equity and debt capital and the most significant number of sophisticated institutions and analysts. In addition to traditional IPOs, the U.S. has a booming SPAC market that may provide an accelerated path to public status and tens of billions of investible capital. A U.S. listing arguably is still the most effective platform to build a global brand for Chinese companies with ambitions for overseas expansion.
To create a "level playing field," regulators in U.S. and China need to work out an effective mechanism for the Big Four accounting firms' Chinese affiliates to have their work on U.S.-listed clients inspected by the PCAOB. These mechanisms must also protect data that relates to China's legitimate "national security" concerns. The SEC may also want to reconsider a number of the disclosure and corporate governance exemptions provided to "foreign private issuers." These exemptions include the absence of detailed quarterly financial reports and limited reporting of insider trading activities. Without minimizing the challenges, resolving these issues is crucial to bolster investor confidence and maintain U.S. capital markets' global standing.
According to the Hurun Report, China is home to 227 out of the 586 "unicorn" companies in the world that have received venture investments giving them a valuation above $1 billion. Chinese companies make up six out of the ten most highly valued unicorns globally, with Ant Group, Bytedance and Didi Chuxing ranked #1, #2, and #3, with valuations of $150 billion, $80 billion, and $55 billion, respectively.
It is hard to believe that fund managers or retail investors looking for exposure to global growth companies will be willing to forego the chance to invest in Chinese IPOs. So, the quandary facing U.S. regulators is whether they can better protect investors by allowing them to trade these stocks in foreign jurisdictions or with the enhanced disclosure regime provided by SEC reporting standards.
Thus far, in Q3, an additional 10 Chinese companies have filed public registration statements with the SEC. However, not one of these deals has an offering size of over $100 million, and only one, iHuman, is sponsored by a bulge bracket investment bank. China is certain to generate a flood of innovative "tech tigers" with a voracious appetite for capital in the years to come. How much of this wave makes it to American shores remains to be seen.