This
week's special edition on why Chinese companies do not go public in
China is in response to a question posed by Mark Cuban. In case you
live on another planet, Mr. Cuban is the highly successful entrepreneur
who made a few billions with a B on his sale of Broadcast.com to Yahoo
back in the day. Currently, he is the owner of the Dallas Mavericks.
About three weeks ago Mr. Cuban Tweeted our
highly popular article Checklist
For Chinese Stock Scams.
The traffic killed our hosting company's servers but the necessary upgrades
have been made. China Vesting appreciates the recognition and today's
edition is a special thank you. We dare say no one has ever written
what we are about to disclose. This is a culmination of spending
years on the ground floor in China meeting hundreds of companies and the
"people" involved on every level of the spectrum. China Vesting is
based in Greater China and continues to meet companies and people in the
industry every day. Going forward we will be sharing more of our
insights and introducing Chinese stocks that are good opportunities.
Don't Get It Twisted
First
off, it is important to understand that for Chinese companies, listing
in the U.S. stock market is not their FIRST CHOICE! That's
right...the honest truth...of the estimated 600 or so China companies listed
on U.S. exchanges none of them wouldn't high tail it to the Shanghai or
Shenzhen stock exchanges in an instant...if given the chance. From
a purely capitalistic standpoint...why wouldn't they when the valuations
are downright frothy.
From looking at the Shenzhen
Stock Exchange website the average P/E ratio is 41.19.
The SME Board (Small and Medium Enterprises Board) is a segment
within the main board sports a hefty P/E ratio of 50.44. One
year ago ChiNext, a board within the Shenzhen stock exchange dedicated
to micro caps and emerging companies debuted. ChiNext companies have
been on a tear and the companies listed there are valued at an average
P/E of 63.44.
The
Shanghai
Stock Exchange has a much more reasonable valuation with an
average P/E ratio of "just" 22.48. Compare this to the current
P/E ratio of the S&P 500 which is looking cheap in comparison at 17.51
What the market is saying to everyone is that an average company listed
on the Shanghai exchange is valued 28.3%
more than companies comprising the S&P 500. Shenzhen Stock Exchange
issuers hold a premium of more than 135%
while ChiNext companies are valued at more than 262%
compared to S&P 500 companies.
Why in the world would a Chinese owner aka CEO/Chairman want to list
in the U.S.? The average valuation these deals for Chinese companies
seeking funding in the U.S. capital markets is around 3-5 times trailing
12 months earnings. This is the level at which hedge funds and investors
are willing to invest at. Don't forget the American investors put
in a mountain of terms and conditions that quite frankly no U.S. company
executive would ever agree to. All this...to list in the U.S. and
these days liquidity for China based U.S. stocks have little to no liquidity.
Could these Chinese companies just be gluttons for punishment or is there
more to the story?
Easy (er)
Unlike the
U.S., to list one's company in China is an arduous task that is mind boggling
complicated and very difficult to navigate. There is a queue of companies
just waiting to list on Chinese domestic exchanges and every one of them
has "connections" aka "Guanxi". Well...what happens when everyone
is connected? The market becomes "normal" and no one is special anymore
except for the special cases. The owners of these Chinese companies
have privately expressed their dismay at the cost, time and most importantly
the uncertainty of the IPO process in China.
Many of the companies that seek listings in the U.S. have been rejected
for China listings and are merely seeking Plan B if not Plan C or D.
Many people may be wondering what's so hard about listing in China.
For one you have to be connected and for the most part everyone is.
That is just the prerequisite, the hard part is in getting enough people
to support the company. If the business is a state owned enterprise
(SOE) then there is a red carpet waiting for you but for 99% of the Chinese
business owners, their relationships are not nearly as strong as they need
to be. This comes as a shock and also a slap in the face for many
of these business owners. Having contacts to start and sustain a
business doing $50 million in revenue and netting $8 million is one thing...gettting
approval to sell stock at a P/E around 50 is something entirely different.
One of our contacts at China's largest investment bank schooled us on
how some "things work". As with any IPO or listing on any exchange
there are lots of fees involved. There are the necessary audit fees,
attorney fees, banking fees and last but definitely not least...the miscellaneous
fees. The Chinese business owner needs to consider if all of these
fees are worth paying...many times upfront...without the certainty of a
listing. For many the risks are too great and taking the Plan B road,
although a discount to market versus China, is the safer choice.
For others who actually spent the money and failed the U.S. market represents
a move that can restore some "face".
Moving Assets
There
is a feeling amongst the elite and wealthy in China that things could turn
in an instant. This could be the result of the massive prosperity
enjoyed in the past few years in what is essentially a 61 year old government
regime. If you spent your life in poverty and became super wealthy
within few years....chances are you would feel like the rug could get pulled
out from under you. Too good to be true is how many rich Chinese
feel deep down. Notice the massive amounts of money the Chinese spend
on luxury items and the gaudy display of wealth exhibited by some.
The elite/rich feel and act as if there is some sort of expiration date
on their net worth. Understanding this mentality will allow people
to understand why rich Chinese act a certain way. While blowing massive
amounts of money... the inverse is true as well...with the rich simultaneously
saving hoards of money for a rainy day or....worse.
Renminbi,
China's currency is a highly regulated currency. That means for a
Chinese business owner to "cash out" he needs to sell his business entirely
or figure a way to move his assets offshore. Ironically, the U.S.
allows these Chinese owners to essentially move their equity stakes into
U.S. dollars. Of the 600 or so Chinese companies listed in the U.S.
the majority have their stock certificates in paper form at home under
the rug...(we are serious) or at a U.S. brokerage firm. When these
owners begin to sell their shares they will be sitting on mountains of
cash in the U.S.
China Vesting does not know the exact figures that these small and medium
sized business owners have transferred to the U.S. but it is significant
to say the least.
Conclusion
China
has a fascination for foreign brands (except for Japanese). This is not
to say domestically made goods are horrible since so much of it is shipped
overseas...it's just that foreign brands represent wealth and achievement.
That is why for many Chinese owners...being a NASDAQ or NYSE
company holds distinction. Many people have no idea on the path these
entrepreneurs took to get to their current state. Going back 5 or
10 years these now rich and successful businessmen will tell you that they
had a better chance of going to the moon then becoming a listed company
on a U.S. major stock exchange.
It
is downright inspiring to hear about many of the success stories here in
China. Overall, the majority of companies China Vesting meets are run by
decent people. Their path to success always entails similar attributes
which are not so entirely different than the entrepreneurs in the United
States two or three generations ago. It really is like the Wild West
here but things are changing quickly. The infrastructure changes
in the finance world are slow compares to everything else but that is a
good thing for investors. There many U.S. listed China companies
that really deserve to be listed in China but for the reasons we discussed
above have decided to pursue the "American Dream".
We can also tell you that in China we've met some downright scams and
frauds. After running through almost a hundred cities and meeting hundreds
of companies and people here we can tell you that there is opportunity
in China stocks listed in the U.S. The hard part is deciphering which
ones are legit. Previously, we've kept the bad seeds to ourselves
but in the future we will send our due diligence over to Sharesleuth.