Reading the headlines, one would think that this would be the worst of all possible moments for a Chinese company to contemplate a U.S. IPO. Tensions over issues ranging from trade to managing the COVID-19 pandemic are at a boiling point. The Senate recently passed legislation requiring the SEC to delist Chinese companies whose auditors do not comply with U.S. regulators' inspections. Some commentators have predicted a looming “divorce” between the world’s two largest economies.
And yet, Chinese companies continue to flock to Wall Street, drawn by deep pools of capital, specialized investor expertise, and the potential to build a global brand.
During the first half of 2020, 17 Chinese companies went public on NASDAQ and NYSE, up from 11 in the same period last year. China has accounted for 27% of all new listings in the U.S. this year.
Chinese debuts have underperformed their peers, with average returns of 12% versus a 51% gain for the overall IPO market. But looking at the more substantial Chinese companies that raised over $200 million, average returns have been a sizzling 52%. This includes the fizziest listing day pop of the year by Agora, Inc., which was up 150% on its first day of trading on NASDAQ. In June, many of these deals priced at or above the high end of their expected price range and upsized their offerings in response to strong investor demand.
The stream of new listings is taking place at the same time as many of the Chinese technology darlings — including Alibaba, JD.com, Netease, Baidu, and YUM China — have recently completed or announced their intentions to complete “homecoming” secondary listings on the Hong Kong stock exchange. These offerings provide the opportunity to diversify the shareholder mix with local investors who use their services regularly. And a Hong Kong listing serves as a hedge to preserve access to public markets in case of further deterioration in U.S.-China relations. Investment bank China Renaissance has estimated that such homecoming listings by established Chinese new economy companies could raise $53 billion over the next few years, which would be a major windfall for Hong Kong.
Wealth of Choices for Chinese CEOs
Why are these Chinese issuers still seeking to ring the opening bell in New York when their larger brethren are returning to home shores?
It certainly is not for lack of choices. The Shanghai and Hong Kong stock markets are running second and third behind NASDAQ in global IPO rankings this year, with $13.6 billion and $11.1 billion raised respectively, according to Refinitiv. Shanghai had the largest number of IPOs in the world in the first half of 2020, with 76 new listings, based on the success of the new STAR market dedicated to advanced technology companies. Chinese companies dominated the global equity markets in the first six months, raising $32.1 billion through domestic and overseas IPOs, twice the haul of U.S.-based companies.
High-quality Chinese companies now have multiple alternatives available to raise capital and carefully weigh each listing venue's tradeoffs. Chinese CEOs are very pragmatic and will consider the likely valuation, offering size, and time required to market a deal. While recent reforms have made both Hong Kong and Shanghai more friendly to fast-growing technology companies, the U.S. markets continue to offer the greatest flexibility in raising additional rounds of equity and debt financing to feed these companies’ voracious appetite for capital.
For companies with global ambitions, a U.S. listing may result in a higher profile and level of confidence with potential customers and strategic partners. For example, recent IPO Dada Nexus now boasts American retail giant Walmart as a 10% shareholder, and the CEO of Walmart China sits on its board. The fact that Walmart uses Dada Nexus as a logistics partner may have contributed to investor confidence in its upsized offering. The company’s CEO, Phillip Kuai, said that he welcomed “better auditing and regulation. Only when your entire environment is as healthy as possible, will everyone – including investors and customers – be protected, and the market develop in a healthy way.” When was the last time any CEO welcomed more audits and regulations?
Another recent IPO, Burning Rock Biotech, is in clinical trials for its cancer detection platform with pharmaceutical giants including AstraZeneca, Bayer, and Johnson & Johnson. Being a U.S.-listed company demonstrates a commitment to international standards that a domestic Chinese listing can’t match. As importantly, proceeds from a U.S. IPO can be deployed to fund operations or acquisitions anywhere in the world. Companies that have a strong business justification for listing in the U.S. are more likely to sustain the rigors of being an American public company than those who are merely opportunistic or lack other options.
Balancing Growth with Risk
From an investor perspective, growth has become a scarce commodity in a post-COVID world. China continues to be a fertile ground for companies with rapidly scaling revenues and innovative business models. With this growth admittedly comes risk. The prospectuses of Chinese IPOs are festooned with risk factors relating to their complex ownership structures, restrictions on overseas shareholder rights, and vulnerability to Chinese government policy changes. Since late May, offering documents include a new risk that Congress may pass the Holding Foreign Companies Accountable Act, which could lead to the mass delisting of Chinese equities.
But these risks pale compared to the possibility that economic reopening could be thrown off the rails by a resurgence of the pandemic. And at least for the moment, China has been more effective in controlling the spread of the virus than America or Europe. The nation of 1.4 billion people has reported less than 5,000 total cases of COVID-19 since early March, while America is reporting tens of thousands of new infections each day. The Chinese authorities have been willing to place hundreds of thousands of people on lockdown to contain clusters of a few dozen cases. While draconian, such tactics appear to be working. Daily life and business operations are now humming along at a “new normal” pace in most of the country.
For now, the talk of divorce proceedings between American investors and China concept stocks may have been premature. If the latest crop of IPOs from China deliver on their promises of higher quality governance and accounting practices — and just as importantly, if they make their numbers — it could rekindle a lasting love affair.