what this means for investors, start-ups

Traders work during the IPO of Chinese ride-sharing company Didi Global Inc on the floor of the New York Stock Exchange (NYSE) in New York, U.S., June 30, 2021.

Brendan McDermid | Reuters

BEIJING — Investors may have to think twice about betting on Chinese tech start-ups as new regulations are imposed on mainland companies seeking to go public in the United States

If listing in Hong Kong becomes the only viable option, fund managers will likely have to rethink their investment strategies, as there are practical differences with how New York stock exchanges handle IPOs.

Since the summer, China and the United States have raised the bar for Chinese companies wishing to trade in New York.

Investors are not the only ones concerned. Chinese companies looking to raise capital face greater uncertainty over their path to listing on public stock markets, and possibly lower valuations as well, analysts said.

Beijing’s actions have more imminent consequences. From February 15, China’s increasingly powerful Cyberspace Administration will officially require data security reviews for certain companies before they are allowed to register overseas.

Aside from the technical complexities of why and how Chinese companies have worked with foreign institutional investors to list in the United States, the new regulations could mean that similar IPOs in the future will likely have to go to Hong. Kong.

For tech companies, that could mean lower valuations than if they were listed in New York, said Richard Chen, managing director of Alvarez & Marsal’s Transaction Advisory Group in Asia.

He said a market familiar with Silicon Valley could put a higher price on a tech company’s growth potential, compared to Hong Kong’s emphasis on profitability and familiarity with business models for companies operating physical stores or working in areas such as semiconductors and precision engineering.

With China’s new regulations, Chen said his clients – mostly traditional private equity firms – are turning more to traditional industrial companies and companies that sell to other companies or sell to consumers without relying too heavily on technology. .

“That’s what our clients think about: ‘Does it make sense to look at these sectors if ultimately it will be difficult to list in the United States given regulatory concerns?'” said Chen. He added that clients are also rethinking their investment strategies wondering if their minimum return targets might be more difficult to achieve as a listing in Hong Kong has led to a lower valuation.

What this means for investors

Faced with the potential for lower returns – or the inability to exit investments in the foreseeable timeframe – many investors in China are holding back new bets. That is, if they can raise funds for their funds to start.

Data from Preqin Pro shows a sharp decline in fundraising by China-focused venture capital and private equity funds denominated in US dollars and yuan in the third and fourth quarters of 2021.

For US-dollar funds focused on early-stage Chinese start-ups, annual fundraising since the start of the pandemic in 2020 has fallen below $1 billion a year – down from $2.43 billion in 2019 and $5.13 billion in 2018, according to Preqin.

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While start-ups may be looking for support, China-focused US dollar-denominated funds are capital-seated. A measure of undeployed funds, known as dry powder, reached $45 billion in June 2021 – the highest level in at least 10 years, according to the latest data from Preqin.

“Due to the uncertainty surrounding the exit, we slowed down our pace of investment in the second half of last year,” Ming Liao, founding partner of Beijing-based Prospect Avenue Capital, said in Mandarin, according to a report. CNBC translation. The company was managing $500 million as of the summer and had previously planned to list some of its US-invested companies last year.

“In practice, the United States is the best exit route for Chinese internet and technology companies,” Liao said. “There is a strong acceptance of new models and a high tolerance for non-profitability, while liquidity is very good.”

Last year’s average daily turnover for stocks in Hong Kong, a measure of liquidity, was around 5.4% that of the Nasdaq and New York Stock Exchange in the United States, according to a China Renaissance report released earlier this month.

Even for big Chinese companies like Alibaba and JD.com, the average daily turnover of their shares traded in Hong Kong is between 20% and 30% of those traded in New York, according to the report. Analysts added that Chinese companies listed in the United States generally price their secondary listing in Hong Kong at a discount.

Chinese IPOs in the United States were heading for a banner year in 2021, until the listing of Chinese company Didi in late June on the New York Stock Exchange caught the eye of Beijing. Within days, China’s cybersecurity regulator ordered Didi to suspend new user registrations and remove her app from app stores.

The move exposed the enormity of Chinese companies’ compliance risk at home and marked the start of an overhaul of the overseas IPO process.

Among several measures, the China Securities Regulatory Commission announced new draft rules in December that set out specific requirements for filing an overseas listing, and said the commission would respond to such requests within 20 business days. following receipt of all documents. The commission ended the public comment period on January 23, without revealing an implementation date.

We expect this uncertainty to dampen investor sentiment, potentially depress Chinese IPO valuations in the US and make it harder for Chinese companies to raise funds overseas.

In remarks to reporters last week, Li Yang, chairman of the government-backed think tank National Finance and Development Institution, described the new draft rules on Chinese overseas IPOs. as bringing the country more in line with international standards for institutional investment.

Meanwhile, the U.S. Securities and Exchange Commission in December asked Chinese companies to disclose more details about their regulatory risks and their ties to government lenders. White House sanctions against some Chinese companies like SenseTime briefly disrupted IPO plans.

Foreign financial institutions involved in Chinese IPOs face growing “business risks” if the invested company “is sanctioned because of its reputation with the U.S. government”, Nick Turner, a Hong Kong-based attorney at the firm lawyers Steptoe & Johnson. “This is now one of the main areas of focus in the due diligence process before any IPO.”

What this means for startups looking to register

The path to an IPO in Greater China or elsewhere remains uncertain, even if prices are favourable.

“For (Chinese) companies applying for overseas listing, they probably have to wait for further clarification from regulators on both sides, and can expect stricter scrutiny, regulatory clearance and prior approval from different agencies. and authorities,” the analysts said.

“The new rules could impose long waiting periods for companies wishing to list overseas,” analysts said. “We expect this uncertainty to dampen investor sentiment, potentially depress Chinese IPO valuations in the United States and make it harder for Chinese companies to raise funds overseas.”

After the high-profile suspension of the planned IPO of Alibaba affiliate Ant in Hong Kong and Shanghai in late 2020, authorities have also delayed the IPO of computer maker Lenovo and the seed company Swiss Syngenta on the continent last year.

More than 140 companies have active filings for IPOs in Hong Kong, according to the Hong Kong Stock Exchange website. A report by EY showed the backlog of companies wanting to go public on the mainland or in Hong Kong remained above 960 at the end of 2021, little changed from June, before the last regulatory review.

Ahead of the IPO, 12 Chinese companies joined the list of new unicorns – private companies valued at $1 billion or more – in the second half of last year, according to CB Insights. In contrast, India added 26 unicorns and the United States gained 148 unicorns during this period.

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