Focus shift on trading places

Lessons to learn for chinese enterprises setting up shop in europe

A total of 342 Chinese companies listed outside of the Chinese mainland and Hong Kong, raising $27.8 billion (22 billion euros) between 2002 and 2011, of which 155 companies listed on other Asian exchanges, primarily Singapore, 135 listed in North America (excluding secondary listings), and only 52 listed on European exchanges, according to data analysis firm Dealogic.

By value, the majority of the capital, $18.8 billion, has been raised in North America compared with $6.1 billion on Asian exchanges and only $2.9 billion in Europe.

Within Europe, the Alternative Investment Market of the London Stock Exchange has been the most popular listing venue, with 34 companies raising $2.3 billion, followed by Germany with 10 companies raising $600 million, and France with eight companies raising $31 million.

So why have the US markets been historically so popular for Chinese companies and why has Europe not attracted more Chinese companies to its markets? A number of factors have shaped this overseas listing landscape for Chinese companies.

The first is the historic prestige of the US markets. The New York Stock Exchange and Nasdaq are seen as the "gold standard" destination for Chinese companies. There has also been a larger community of US-networked bankers and other market professionals operating in China than a European one. The NYSE and Nasdaq have also been more active in marketing in China than the London Stock Exchange or Deutsche Boerse.

The second factor is the continuing importance of the US exchanges for technology and Internet sectors. This trend is likely to stay in the foreseeable future, given the continuing popularity of technology stocks - despite the controversy surrounding the Facebook float. Europe is comparatively weaker in technology IPOs.

And the third: backdoor listings and activity of intermediaries promote faster and cheaper access to capital. Listing rules in the US had allowed new issuers to come to market through reverse acquisitions of existing listed shells without the scrutiny of the normal IPO diligence and regulatory process.

This loophole may have been used by less scrupulous or experienced intermediaries, resulting in listings of a number of companies that were not ready or suitable to become public. As a result, the Bloomberg Chinese Reverse Merger Index lost more than twice as much value over the last year as the more generic Chinese IPO index. Reverse mergers are more tightly regulated in Europe, with higher diligence standards, especially in London.

However, in 2011 there were only 16 IPOs of Chinese companies in the US, raising $2.9 billion, which represented a decrease in volume of 62 percent and in value of 26 percent when compared to 2010. For the first time, the value of Chinese companies delisting from the US exchanges exceeded new listings. This followed a series of accounting irregularities at the start of 2011 and accompanying negative publicity.

Market participants expressed concerns about the quality of financial reporting and controls by Chinese companies publicly listed in New York, Hong Kong and Toronto, with the most notable case being Sino-Forest, a Chinese timber company which was delisted from the Toronto Stock Exchange last month.

So far, Chinese companies listed in the UK and the rest of Europe, while not being completely immune, have avoided the worst of the accounting scandals, largely as a result of the more rigorous diligence standards imposed on investment banks in London.

As a result of the investor backlash in the US, we expect the European markets to increase in popularity in the near future. However, companies need to ensure they are ready to access the public markets and can persuade investors that recent issues reported by the press were isolated incidents unlikely to be repeated.

So what can we recommend Chinese companies to focus on in order to maximize their chances of success? In our view, these would include:

1. Strong corporate governance.

Investors consider opaque related-party transactions with shareholder-related businesses outside of the IPO structure as key risks. It is critical that these are reduced, made transparent and reset on an arm's length basis. A strong respected board of directors is essential.

2. Transparent business models.

Unusually high margins, low effective tax rates and reliance on a limited number of customers or suppliers are likely to be of concern to investors. These should be revisited well in advance of an IPO and rebuilt on a sustainable basis. Any irregular business practices or aggressive tax schemes should be terminated.

3. Quality of earnings and cash flows.

Effective working capital management and sound capital expenditure planning will reassure investors. Cash flow models, budgets and operating plans all need to be improved and aligned in anticipation of an IPO.

4. Legality of transfer of Chinese shares or assets to a new overseas holding company in a pre-IPO group restructuring.

Compliance with Ordinance 10 needs to be ensured and, more broadly, any tax and legal restructuring should be planned and completed by experienced advisers prior to listing.

5. Selection of well-respected and internationally recognized advisers.

Companies should be particularly wary of the promise of speed and low cost, as this usually ends in problems.

Given the volume of Chinese IPOs in the past 10 years, it was perhaps inevitable that some high-profile scandals occurred, which unfortunately tarnished the reputation of the good, solid Chinese businesses that aspire to become successful public companies.

By learning lessons from the pitfalls of others, preparing well and focusing on the key risk areas, Chinese companies will undoubtedly achieve new heights in the global capital markets, including those in Europe.

The author is head of the PwC International IPO Center in London.

(China Daily 06/15/2012 page7)