The Wild West: Relaxed U.S. Listing Standards Create Opportunities for Chinese Companies
Fan Chen 陳凡, MBA, MFE
Managing Director, Research and Portfolio Management
U.S. investors often imagine their domestic stock markets are best-in-class: tightly regulated platforms for the world’s highest-quality companies. But as with many things, the rest of the world sees the U.S. differently than the U.S. sees itself. To much of the world, the U.S. listing process looks more like the wild west.
This is especially true from the perspective of Chinese firms. To the surprise of many U.S. investors, China’s listing standards are more stringent than those in the U.S., including long waiting periods, heavy regulatory oversight, and rigid performance thresholds. Chinese companies that don’t meet local listing requirements or can’t withstand regulatory scrutiny – or those who aspire to the grandiose valuations prohibited in China – look to U.S. exchanges instead.¹
The Gold Rush
The U.S. government has been talking tough about Chinese companies, but in the six months following former President Trump’s delisting order, the number of Chinese firms listed on equity markets actually rose 14%, from 217 to 248 companies.² About 50 more U.S.-listed IPOs of Chinese companies are estimated for 2021.³ These are record-breaking numbers, and they show no signs of slowing.
Just as the California gold rush brought an influx of miners seeking their fortune, Chinese companies listing in the U.S. hope to strike it rich before the bonanza ends. This includes many internet, service and other “new economy” businesses seeking to avoid the valuation cap on IPOs in China⁴ – which is roughly 25x P/E outside of GEM/STAR. Such “new economy” companies will continue listing in the U.S., where they can achieve 30x, 35x or even more. These firms are in the grip of gold fever.
Outlaws and Lawmen
Of course, companies with high valuation multiples are not always high-quality companies. U.S. investors often falsely assume that Chinese companies listed in the U.S. are the top-performing companies in China. But just as an outlaw could start anew in the west – fleeing local law enforcement and a bad reputation – so can low-quality Chinese firms come to the U.S. and rely on information asymmetry to fool investors.
As noted above, it’s actually harder to list in China than in the U.S. In addition to restrictions regarding legal and capital structures, Chinese regulators subject companies to lengthy and often costly regulatory reviews prior to listing. The scope of this scrutiny can be broad and difficult to predict, including financial health, firm culture, political environment, social benefit, and “soft” quotas. In China, regulators take a holistic and paternalistic approach to ensure each listed company is of sufficient quality and will not present a risk to investors in an overheated IPO market.
Given the heavy-handed regulatory approach in China, it’s not surprising some companies choose to flee the country and seek their fortune on more liberal U.S. exchanges. The challenge for investors – just as it was in the wild west – is separating the good guys from the bad guys. Which of the companies coming to U.S. exchanges are high-quality firms pursuing higher valuations, and which are low-quality firms trying to avoid local regulatory scrutiny?
Boom or Bust
It’s clear that at least some of the Chinese companies listing in the U.S. are reputable firms with promising prospects. For these firms, the U.S. listing process offers substantial and legitimate advantages over a domestic listing.. Unfortunately, these same benefits also attract lower-quality firms.
During the gold rush, it took a highly trained eye to separate good claims from bad. Even then, a miner’s success was often a matter of good luck or ill fortune. In fact, the only person guaranteed to make money from a miner’s gold claim was the land speculator who sold it. Similarly, many IPO investors of U.S.-listed Chinese companies have had a “boom or bust” experience. The only surefire winners from these IPOs have been the Chinese companies issuing their shares.
This has lead Phil Wool, PhD, Rayliant’s Head of Investment Solutions, to question whether it’s advisable for investors to participate in Chinese IPOs – regardless of where they are listed. In the U.S., there is adverse selection from companies seeking outsized valuation multiples. But IPOs in mainland China and Hong Kong are frequently oversubscribed by exuberant retail investors, making it difficult to get a piece of the action in the offering, and leading to inflated prices in post-IPO trading.⁵ In either case, it often isn’t clear to investors for months or even years whether a claim is a boom or bust.
An End to the Bonanza
Despite shifting regulatory landscapes in both the U.S. and China, there is nothing in the near term that will slow the trend of U.S. IPOs of Chinese companies. So long as Chinese companies are permitted to take advantage of the easier process and higher valuations for U.S. listings, they will continue to do so.
The critical thing for U.S. investors to understand is that Chinese companies listed on U.S. exchanges are not necessarily high-quality firms – they are simply the Chinese firms that believe U.S. listings are easier and richer. Investors seeking broad-based China exposure should know that many of the highest-quality Chinese firms are and will continue to be listed exclusively in mainland China.
¹The U.S. listing process is different than China’s in part because U.S. markets are more efficient. Chinese markets are still dominated by retail traders. The Chinese government feels an obligation to protect these inexperienced investors from ill-advised IPOs in an overheated market. By contrast, U.S. markets are dominated by professional institutional investors. These investors can make better informed decisions that have a self-regulating effect, allowing the U.S. stock market to operate more efficiently and with less government intervention. These features of the U.S. stock market promote the growth and innovation of listed companies – even as if they do create greater risk for some retail or inexperienced investors.
²“Despite delisting concerns, the number of Chinese companies on US equity markets rises”, 14 May 2021 | South China Morning Post (last checked 22 June 2021)
⁴“Chinese IPOs underpriced by up to $200bn due to valuation limits”, 19 February 2021 | Financial Times (last checked 22 June 2021)
⁵For example, the shipping arm of Chinese retailer JD.com saw it’s late-May IPO oversubscribed by 715x.
This article was first published to LinkedIn:
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