China's tight IPO market
Play
The success of most of the leading companies in China today was made possible because of the support they received from private investors at an early stage of their development. However, many private investors in China today may be wondering about the end
They need to know they have a viable and ready exit strategy, so they can realize their investment when they want to. Typically, this will be through IPOs. But private Chinese companies wanting to go public and list on the nation’s stock exchanges face significant obstacles, and on average fewer than 150 private-equity backed companies go public each year – a relatively small number for an economy of China’s size.
Hundreds of companies wanting to list each year must therefore wait in line, and the signs over the past six months are that IPOs are slowing down even further.
One of the restraints on IPO numbers is the tight control maintained by the securities regulator, the CSRC, whose primary goal is to assure the stability of the capital markets. While the CSRC does a good job in ensuring that only credible companies make it through to listing – virtually guaranteeing that all IPOs in China will be successful – it does make it tougher for companies to go public.
The issue of viable exit strategies for private investors is important because China’s private equity market is one of the keys to the country’s economic success. Virtually all of China’s largest and most dynamic private businesses were financed by private equity or venture capital, and the funds in question are huge: China First Capital, a boutique investment firm based in Shenzhen, estimates that more than US$100 billion of initial capital may be tied up in investments made by private equity firms in China since 2001.
So what other IPO outlets do private-equity-backed companies have? Offshore markets are less hospitable to Chinese companies than before. In the US, for example, there is little or no investor interest. As the Wall Street Journal has noted, investors have lost billions of dollars on Chinese reverse mergers over the past few years, after some companies were accused of accounting fraud and exaggerating the quality and size of their assets. This had a spill-over effect on other Chinese companies that used a conventional IPO process in the US.
In Hong Kong, generally only bigger Chinese companies are welcome. And smaller markets – such as Australia, South Korea and Singapore – offer much lower valuations than in China.
With IPOs relatively scarce, the most obvious alternative exit strategy for investors seeking to realize the value of their investment is mergers and acquisitions (M&A). But analysts say M&A activity is being held back by a shortage of domestic buyers with cash or shares to use as currency, regulatory issues, and the fact that many of the best private companies in China are founded, run and majority- owned by a single highly-talented entrepreneur. If he or she sells out in the M&A deal, the new owners will have a hard time doing as well.
I have no doubt that private equity investors will continue to be attracted to Chinese firms, drawn by the opportunities offered by the many great ideas and companies developed by Chinese entrepreneurs who need outside investors to grow. But if the tightness in the IPO exit pipeline continues, it will dampen some of that enthusiasm.
For more columns in this series please see www.bangkokbank.com
