This is part one of a two-part interview with Chien Lee, founder of Chinese private equity fund NewCity Capital. Click here to read part two.
In the third quarter of this year several Chinese companies listed in the US, reviving memories of the last wave of such IPOs in 2010. That trend came to abrupt halt when Wall Street started calling “short China” on Chinese stocks amid widespread accounting mispractices. Firms were found to have lied about their numbers, and many chose to delist as investor sentiment soured.
Since then Chinese firms listed in Hong Kong have also come under scrutiny while Muddy Waters, the short seller who triggered the market panic in the first place, recently accused a high-profile firm of irregularities. That hasn’t scared away all investors – many of the recent IPOs were heavily oversubscribed.
For Chien Lee, founder and chairman of private equity firm NewCity Capital and co-founder of two US -listed enterprises focused on China, Chinese firms listing abroad should be judged on their individual merits, not lumped together. Lee, who spoke with China Economic Review in December, said the controversial VIE structure used by many Chinese firms is fundamentally solid and should not trigger unnecessary alarm bells.
Investors remain concerned about fraud at US-listed Chinese companies. Is this a regulatory or cultural problem, and what can be done about it?
It is not the culture; Chinese people are basically honest. Some companies didn’t follow the rules and regulations and maybe just affected other Chinese companies listed in the US. Some companies should never have been listed in the US in the last five to 10 years. There were really bad companies. In the last few years, they have been delisted and had a few fraud issues. That’s true, but it’s just a minority.
The majority of Chinese companies are fundamentally right, they have proper governance, and they have followed rules and regulations, and they are really solid companies. In my opinion, it is not about the culture or the regulators because the rules and laws are there, you need to follow it. You need to have proper governance.
You know, the same thing happens elsewhere. In America, you also have the majority of very good companies. But you still have a minority of companies [that have problems]. Either the industry is not too good, or the companies don’t have proper corporate governance or some other issues. You have to look at the broader market. You know that China is growing, you need to look at an industry that is a good industry and you need to look at individual companies case-by-case.
What are the challenges likely to be faced by Chinese companies listing in the US?
The challenge would be that you need more transparency and corporate governance. You have to follow the rules and regulations in the US. You try to do a good job and stay a clean company, then you will be doing fine.
What are your thoughts on the controversial VIE structure used by many Chinese companies that go public overseas?
My opinion is that the VIE structure is a fine structure. It has been there for maybe 20 years. Sina was the first one to use it and today Sina is fine, it is doing great, one of the best Chinese companies listed in the US. So it doesn’t have too much to do with the structure. It is about how people follow this structure. If you have a proper contract and the management honor that contract then you will be fine.
Direct equity ownership and the VIE structure are a little bit different but it [the risk] is the same. Say you are the direct equity holder with the law and proper paperwork, say you have some assets and you sell those assets, you have cash that you will distribute to the shareholders. The VIE structure is the same thing. You have a shareholder agreement, so when the company goes under either you have assets or you sell the assets and have cash, and then you must priortizie who the money goes to. Companies should follow the rules.
Even if you are an equity shareholder, if the company doesn’t follow the rules and regulations, and they get the money and don’t give it to you, it’s the same as if you are a VIE shareholder. It’s about the company and the people. The people are honest or not. Look at a company like Sina: They honor the VIE structure and are doing fine. It is about the company and people who run the company and how they handle these structures.
Why are HK and the US the preferred overseas listing destinations for Chinese companies?
There are a couple of reasons. The first is that the US and Hong Kong are the biggest capital markets for Chinese companies because there is more marketing opportunity and liquidity there. The second is the brand recognition. People prefer being listed in the US and Hong Kong markets more than other markets.
It seems like it is a little bit difficult for other boards to attract Chinese companies?
You know how many companies there are in China and how many Chinese companies are waiting for an IPO. But still, other countries need to be more aggressive and need to put more into their exchanges. They need to give more to service Chinese companies and make them more comfortable in their countries.
What is your view on short sellers like Muddy Waters and Citron? Do they have a role to play as market watchdogs, or are they more trouble than they are worth?
I don’t have a personal opinion on this because it is still too early for me to judge. I would like some more time to make my own judgment on whether this is good for the market or isn’t.
China has suspended domestic IPOs for more than one year now. If this continues, what are the options for cash hungry Chinese companies?
This not just a question of companies raising funds but also about exit strategies for investors. China needs more M&A (mergers and acquisitions). That is one thing to think about. In the US most investors in companies, 60-70% I believe, exit their investments through M&A. The other 30% is through IPO. So the China market has to do more M&A in order to generate more fundraising and also for investors to be able to exit say a PE (private equity) investment.
So what needs to change in China for M&A activity to progress?
That is a little bit about culture. Most Chinese companies are owned by families, but in the US, a lot of businesses are corporate run. So when you do M&A in China it is kind of difficult. When the company is founded and run by a family, you have to think about how to merge the management team and how to integrate it [into the new company] and that is a big issue. That’s why China does not have much M&A.
China is starting to get big companies that are not family run but corporate run, where you can change your CEO tomorrow but the company is still good. But in a lot of family run companies, if you change the CEO tomorrow, it stops operations.
Going forward the second generation [the children of the original entrepreneurial class unleashed in the 1980s] is coming. The second generation is coming in and they have mostly studied overseas, but also have a Chinese background, so when they take over the family business they will understand modern management practices. Going forward we will have more M&A in China.
How do you see the development of the Chinese equity market?
The Chinese equity market is kind of new and does not have mu
ch history. The Chinese government really carefully opens up the capital market step by step. I think they are doing it the right way and eventually they will open up to that [riskier products] as the market needs that, but it won’t be everything at one time.
You need to let the market mature and to let the people understand the market and practice on the market for a period of time then they will start opening up more options for the market. I think it is the right approach. Reforms take time; there is a need to test the market, to make sure it is not corrupt.