What China's IPOs Don't Like About the U.S.
from
September/October 2006
by Craig Mellow
What are the hottest young companies in the U.S.? Focus Media Holding Ltd. and Baidu.com.
The two Chinese newcomers both listed on NASDAQ last year and turned into the top-performing IPOs in the U.S. over the following 12 months, according to data tracker Ipohome.com. By mid-July, shares in Focus Media, a Shanghai outfit that specializes in outdoor advertising, had almost quadrupled from their July 2005 issue price, to $64. Stock in Baidu, the Beijing-based would-be Google, had nearly tripled since August 2005, to $81. This at a time when the broader appetite for Chinese stocks was modest; Hong Kong’s Hang Seng index rose about 9%. The NASDAQ, where these two are traded, was virtually flat.
Yet rather than celebrating these listing coups, America’s exchange chiefs are fretting about the ones that got away. “Regrettably, Chinese and other foreign companies are simply concluding that it’s not worth it to come to our market,” Marshall Carter, chairman of the New York Stock Exchange, told Congress in April while testifying on the effects of class-action lawsuits and the Sarbanes-Oxley statute.
Indeed, both Focus Media and Baidu, while they make thrilling stories, are the exceptions to the general abandonment of U.S. exchanges by non-U.S. companies looking to float equity. NASDAQ hosted seven Chinese IPOs last year and expects a similar number in 2006; the NYSE hosted one new Chinese company in 2005 and none through the first six months of 2006. Those numbers stand in sharp contrast to the multibillion-dollar deals generated over the same period by privatizing Chinese state companies, which have increasingly shunned the U.S. since Sarbanes-Oxley was passed in 2002. The NYSE expected action to pick up in the second half of the year, however, promising “a handful” of Chinese IPOs.
Three of the five biggest IPOs in the world in 2005 were Chinese: China Construction Bank ($9.2 billion), China Shenhua Energy Co. ($3.3 billion), and Bank of Communications ($2.2 billion). All listed exclusively in Hong Kong. This year Bank of China went public for $11.2 billion—in Hong Kong.
The rest of the world is likewise voting with its feet because of the reforms mandated by Sarbanes-Oxley, in particular Section 404, which requires setting up internal reporting systems that can cost millions of dollars. In 2005, 189 companies, from Egypt Telecom to Russian steel producer Evraz Group to India’s Moschip Semiconductor, went outside their home markets to list their stock—but not to the U.S., according to NYSE data. Before Sarbanes-Oxley, the U.S. outdrew the rest of the planet two to one in the number of offshore listings. Among the mega-offerings on the NYSE from 2000 to 2002 were China’s two state oil companies, PetroChina and Cnooc, and phone companies China Unicom and China Telecom.
Most frustrating to the U.S. exchanges trying to pitch their virtues overseas is that there are positive reasons for listing here, particularly on NASDAQ. While the NYSE’s historic liquidity advantage for blue chips over other world financial centers like Hong Kong may have all but disappeared, NASDAQ is generally viewed as a still-unique platform for cutting-edge companies. “There is no market that understands our business better than the U.S.,” Shawn Wang, chief financial officer of Baidu.com, has said. “For a technology offering, the NASDAQ is the place to be.”
Corporate governance advocates would add another reason for listing in the U.S.: the prestige of making it past the world’s most stringent governance barriers. “Greater transparency and accountability in U.S. capital markets results in a lower cost of capital,” argues Nell Minow, editor of the Corporate Library watchdog group. “That will continue to attract businesses from around the world, once they realize the benefits outweigh the costs.”
This view gets some support in the corporate sphere. Vivendi, a French conglomerate that has decided to delist from the NYSE, will maintain Sarbanes-Oxley compliance voluntarily. “We found we could trade just through Paris, but our U.S. investors are comfortable with our existing governance standards,” says company spokesman Antoine Lefort. A threatened mass exodus of U.S.-listed foreign companies that was predicted by some when Sarbanes-Oxley passed hasn’t materialized. But Vivendi’s departure is a harbinger of more such desertions, according to Big Board chairman Marshall Carter.
Section 404 is not the only factor scaring large Chinese companies out of the U.S. The last super-IPO by a state company was China Life Insurance’s $3.5 billion issue on the NYSE in late 2003. Three months later, Chinese regulators announced that they had found some $675 million in accounting irregularities at China Life’s predecessor company. The shares took a 25% hit, and although they’ve recovered, the company still faces a U.S. shareholders’ class-action suit. “After China Life got sued, other companies got the message” to stay off American exchanges, says attorney Robert DeLaMater, a partner at Sullivan & Cromwell and
a veteran of Chinese securities transactions.
The Securities and Exchange Commission has historically striven to minimize regulatory fine print with the aim of luring overseas firms to U.S. shores, DeLaMater says, starting in 1934 with exemptions from certain proxy-voting and insider-trading strictures. But the SEC is cutting no slack with Sarbanes-Oxley. Section 404 went into effect for overseas companies this year. The SEC’s recent announcement that smaller businesses will also have to adhere to 404 applies to small foreign companies too.
Carter and the NYSE have shifted to pressing Congress for a more subtle reform, outlined by the chairman before the House financial-services subcommittee on capital markets. This would restrict the annual Section 404 report for all companies to “significant income statement and balance sheet assertions where the risk of material misstatement would prove harmful to investors,” and require the current stem-to-stern risk review only once in three years. “For example, a bank would report annually on how it controls its loan portfolio, but not on every employee’s expense account,” says exchange spokesman Christiaan Brakman. DeLaMater doesn’t think the SEC will back down, however. “There is no recognition in government of the need to attract foreign companies,” he says. “There is indifference.”
A more optimistic take comes from Chris Sturdy, head of the depositary-receipts operation at the Bank of New York, a leading depositary of both American depositary receipts and their foreign counterparts. The governance gap between New York and other top financial centers is bound to shrink in the long run, says Sturdy, who is also the bank’s executive vice president, as Washington tinkers with Sarbanes-Oxley and rival markets tighten up. “The EU and other jurisdictions are adopting their own governance codes, and some of them are not pretty, either,” he says. “In time the playing field will level some.”
IPO flight has not stopped American money from pouring into foreign stocks. The top two holders of depositary receipts from Hong Kong, London, and all other markets last year were U.S. fixtures Fidelity Management & Research and Capital Research & Management, which invested $62 billion between them, according to the Bank of New York. Further, SEC Regulation 144A leaves a giant loophole for foreign issuers, because it allows them to sell stock to U.S. institutional investors so long as they don’t try to sell directly to the general public. According to NYSE figures, U.S. institutions committed $80.5 billion to foreign-listed IPOs last year, compared with $5 billion to new U.S.-registered issues. That’s a bitter pill for New York financiers who are missing out on the IPO-related fees to swallow. But for directors and executives of non-U.S. companies, it is a signal that they can tap the world’s richest investment pool while keeping themselves safe from both contingency lawyers and Sarbanes-Oxley.
