Why you should care
Beijing’s plans to ease regulations to woo the return of its tech titans aren’t working out as smoothly as hoped.
China’s plan to lure homegrown tech unicorns such as Alibaba and Baidu on to domestic capital markets has been hit by a bearish mainland stock market and concerns from investors and issuers over a government-enforced cap on share prices.
China’s Cabinet formally approved a framework in March to allow foreign-listed companies in strategic industries to bypass rules governing mainland initial public offerings, including bans on exotic structures such as dual-class shares and variable interest entities. Such prohibitions had pushed Alibaba, Baidu and JD.com away from the Shanghai and Shenzhen bourses to New York, sparking embarrassment and soul-searching in Beijing and prompting the listing mechanism known as China depository receipts (CDRs). But in recent weeks these three groups have all delayed plans to issue CDRs, according to people familiar with the matter, raising doubts about the future of the program.
“The intention of the national push for CDRs and bringing everyone home was good,” says the head of the Hong Kong office of a mainland securities company, who asks not to be named because the issue is sensitive. “Chinese investors should be able to participate in the run-up of these companies. But there is too much uncertainty in China today.”
All three companies declined to comment.
We already have a lot of investment, and the market is very weak, so of course we don’t want others to come and draw out more blood.
Shu Qiquan, Qianbo Asset Management
The delays are partly an accident of timing. The mainland stock market has fallen sharply since mid-June and entered a bear market, creating a less hospitable environment for new share sales. China’s securities regulator traditionally restricts the flow of IPOs during periods of market weakness to avoid siphoning demand away from existing shares. But this option is less available at the moment because the regulator has accelerated the pace of IPO approvals over the past year, creating a backlog of 22 companies that are cleared to list this year but have not yet done so, according to data from Wind Info.
This pending supply overhang is among the reasons for recent market declines, and the addition of CDR deals to this pipeline could further pressure mainland indexes.
“From an investor’s perspective, we don’t want CDRs right now,” says Shu Qiquan, general manager of Qianbo Asset Management, a Chinese hedge fund focused on tech companies. “We already have a lot of investment, and the market is very weak, so of course we don’t want others to come and draw out more blood.”
In a bid to reduce the impact of CDR deals, the China Securities Regulatory Commission (CSRC) approved the launch of six mutual funds to raise a combined RMB 300 billion ($45 billion) earmarked for investment in CDRs. Advanced fundraising of dedicated CDR funds was designed to prevent these deals from drawing cash away from other shares.
But fund company disclosures this week indicate that the six funds managed to raise only RMB 104 billion, highlighting the lack of investor excitement for CDRs.
“Investors look at companies like Alibaba and JD.com and see that they’re already very large. They don’t see an opportunity for high returns within a short period,” says Gary Liu, president of the China Financial Reform Institute.
The poor reception of mobile-phone-maker Xiaomi’s Hong Kong IPO is also sparking worries that investors are falling out of love with China tech names, after years of warnings about a bubble, though market participants say that Xiaomi’s problems were partly company-specific, as investors were not convinced that it had a well-defined business model.
“This particular Xiaomi issue may not by itself jeopardize the [CDR] program, but with the overall macro environment, trade issues — all this adds up and may slow down some of the momentum,” says a Hong Kong investment banker. Beyond weak market conditions, would-be CDR issuers are also concerned about the regulator’s influence on the pricing of CDRs.
Alibaba’s shares in New York trade at more than 49 times trailing 12-month earnings, while Tencent’s price-earnings ratio in Hong Kong is 36, according to Thomson Reuters data. But the CSRC has unofficially capped P/E ratios for IPOs at 23 in recent years, in a bid to protect retail investors from overvalued shares. At the CSRC’s preferred valuations, unicorns would be selling themselves cheap.
Ai Tangming, chief economics commentator for Sina Finance, says the CSRC may not enforce the unwritten P/E cap for unicorn deals. But he also says that unicorns will seek to avoid the risks that would come with pricing CDRs too highly.
“If they sell at a high price and then the stock price quickly drops, it will damage their relationship with the market,” he says.
Some analysts say that the unicorns will ultimately agree to sell shares at a discount, accepting this sacrifice as necessary for gaining a foothold in mainland capital markets, where — apart from IPOs — valuations are generally higher than in international markets. The CSRC does not strictly control pricing of secondary share offerings, which means that once the unicorns have achieved their mainland listings, they can price follow-on offerings at richer valuations.
“No matter where they’re initially priced, sooner or later the market will bid the price up to where it’s even with the U.S. — maybe even higher,” says Qianbo’s Shu.
Additional reporting by Louise Lucas in Hong Kong.
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