For many Chinese firms, listing in New York, Hong Kong or Singapore looks like a guaranteed get-rich-quick scheme. Online video firm Youku’s listing last year shot up 160% on its first day. Business-to-consumer site Dangdang’s trading debut was so successful it angered the founder, who complained that he had been misled into underpricing the first initial public offering tranche. Inspired, social networking sites Kaixin001 and Renren are rumored to be preparing listing documents; online security providers Qihoo 360 and Netqin have already filed them. If Youku and Dangdang are any indicator, these new listings will also be welcomed by the markets.
But the success of the Chinese dot-coms is not typical. The Halter USX China Portfolio, an exchange-traded fund that attempts to track the performance of Chinese firms listed in New York, has not been an impressive performer compared with overall US indexes, and has underperformed consistently since last December. The same can be said of many Chinese firms trading in Singapore and Europe.
Irritated by low valuations and high expenses, a growing number of firms are giving up, buying back their shares, and taking down their ticker symbols. Gary Liu, deputy director of China Europe International Business School’s (CEIBS) Lujiazui International Finance Research Center, said there are several reasons for the mutual disenchantment. First, he said that while Chinese internet companies have no choice but to list abroad given their lack of profitability, firms with assets and profits have the option to list at home – and that option looks increasingly attractive.
Second, overseas investors don’t necessarily understand Chinese companies.
“Internet companies are easy; investors can easily compare [the Chinese firm] to a similar company in the US. But Chinese medicine companies, for example, American investors don’t understand. They don’t have enough information to value the company,” Liu said.
There are also doubts about honesty. “There are rumors that the [US Securities and Exchange Commission] is making investigations against some of these companies for cheating. It is quite easy for US investors to believe these rumors.”
But where retail investors are put off, wholesalers perceive an opportunity. Because these Chinese companies have – at least on paper – both assets and profits, foreign private equity (PE) firms are rushing to help Chinese firms delist abroad and come home.
“The reason PE wants to participate is because of the valuation gap,” said Ping Luo, analyst at Global Hunter Securities. “They can take the company private at eight times price-to-earnings, and list in Hong Kong or China for at least 15 times price-to-earnings or more.”
Last summer, Blackstone Group invested in China Animal Healthcare, which was dying on the Singapore exchange for lack of volume, and has been trying to move to Hong Kong. In March, CDH Investments announced plans to take Chinese water technology firm Sinomem – also currently listed in Singapore – off the boards for US$276 million. New York-listed China Security & Surveillance Technology is also planning to go private, although the PE investor remains anonymous.
The most dramatic management buyout of the moment is Harbin Electric, manufacturer of linear motors and other components for oil pumps, trains, automobile windows and power plants. Harbin Electric has been trading at low multiples – its price-to-book ratio was 1.6 in mid-March.
Insulted, chairman Yang Tianfu has been trying to buy it back for US$24 per share, but his first attempt failed. Multiple shareholder class action suits were already underway when Baring Private Equity backed off on its commitment to the project, and the buyout is now stuck waiting for another investor to commit. Harbin Electric’s shares plummeted after the deal fell through. In mid-March, they were trading between US$16-18 under heavy pressure from short sellers, despite positive earnings surprises in the previous quarter.
Luo covers Harbin Electric; she said company management told her that Baring had to back out because Nevada law (where Harbin Electric’s US subsidiary is incorporated) prohibits it from buying the majority of the company’s shares: Baring has not been a “beneficial owner” – an owner of more than 5% of the company – for longer than three years.
True or not, this was not the explanation either company gave publicly, and some industry watchers suspect that Baring busted Harbin Electric cooking the books. Harbin Electric’s US listing is a product of the now-infamous reverse merger strategy whereby Chinese firms buy listed US shell companies to avoid rigorous scrutiny applied to newly listing entities. The company also recently acquired a state-owned enterprise called Xi’an Simo; in a conference call, Harbin Electric management admitted that Simo’s books have “problems.” Incorporating in Nevada – the closest thing in the US to an anonymous tax haven – contributes to the company’s image problems.
Worse, Harbin used – and still uses – Frazer Frost, the same auditor employed by the infamous Rino International, which was revealed to have fabricated financials and forced to delist.
This has not stopped the company from trying to go private, but as this magazine went to print no new investor was in place. Chairman Yang has once again sought out the PE firm that first took it public, Abax Capital, and formally indemnified the company’s board of directors and officers against lawsuits. But Abax has yet to commit itself, and there are reasonable doubts that another firm would be willing to step in.
Luo of Global Hunter has been consistently bullish on Harbin, but her optimism is not widely shared. Harbin Electric is a mainland company, and it is difficult for even relatively honest Chinese firms to become successful without taking any shortcuts. Suspecting accounting irregularities is reasonable. But short sellers are betting that the company will ultimately be exposed as a completely fraudulent shell, which seems like a stretch.
Dave Iwinski, managing director of Jin Fu Consulting, a firm with experience taking Chinese firms overseas, is sympathetic to both sides. Some Chinese companies are certainly getting tarred unfairly. On the other hand, what do they expect?
“Not a week goes by without news of some overinflated red-chip company [having problems],” Iwinski said. “You have to shake your head and say, some of this is irrational exuberance, and in some cases it’s irrational apprehension.”