Listing China on offshore markets

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HONG KONG (Dow Jones Investment Banker) – When the board of a good-sized Chinese company is choosing a venue for an international IPO, the short list usually has three names on it: the Stock Exchange of Hong Kong, NASDAQ and NYSE Euronext in the US.

There are many reasons why a company might choose one of the three, but a look at recent Chinese IPOs in each market reveals several trends that corporate boards should bear in mind. Most notably, while the bigger deals tend to go to Hong Kong, and initial pricing tends to be more efficient there, newly listed companies appear on average to sustain higher valuation levels in the two US markets.

Although a few major Chinese firms have listed on Singapore’s SGX (in the property and marine sectors in particular) or London’s LSE or AIM platforms, these exchanges often remain in the second tier.

A survey of recent IPOs using Dealogic and Bloomberg data makes clear some crucial differences between the US and Hong Kong exchanges. Screening for 2010 IPOs in the range of US$50 million to US$1 billion, and where companies have traded post-listing for at least three months, renders 70 Chinese or Chinese-controlled companies listed on the Main Board in Hong Kong (45), on NASDAQ (9) and on the NYSE (16).

Hong Kong is capturing more deals – not surprising given the geographic proximity. More surprising is that the Hong Kong IPOs are, on average, twice as large (US$219 million) as on NASDAQ (US$109 million) or the NYSE (US$121 million).

The size differential may be explained partly by US IPO fees, which remain on average double what they are in Asia, except for the very largest deals. When big money is at stake, that 7% fee starts to sting.

Turning to aftermarket performance, the average first-day premium in Hong Kong for Chinese IPOs was 6.3%. This is true for offering by “red chips,” Chinese issuers that have been incorporated as offshore entities after a corporate reorganization, as well as for “H-share” offerings from mainland-incorporated companies. That compares to premiums of 21.5% for NASDAQ and 13.6% for the NYSE.

This is an admittedly small and unscientific survey, but the differences are stark enough to suggest significant under-pricing for those deals conducted in the US. An IPO is generally considered to be priced well when it achieves a single-digit percentage “jump” above the offer price upon start of trading.

The difference could be explained by the fact that no pre-deal research can be published in the US, in contrast to Hong Kong. Research helps to convey investment cases and validate valuation assumptions.

Interestingly, over a longer, three-month trading period, the US/Hong Kong share performance discrepancy remains broadly similar: +7.8% in Hong Kong, +26.1% for NASDAQ and +22.8% for the NYSE.

In terms of valuation (for those companies for which data are available), the US markets would appear to give Chinese companies a higher current price-to-earnings ratio than the Hong Kong exchange. Price-to-earnings ratios in the sample averaged 24.8x on the NYSE and 28.9x on NASDAQ, as compared to 20.4x in Hong Kong – although the ranges are so wide as to make definitive conclusions difficult. Part of the discrepancy can be attributed to the types of companies that list in the US – NASDAQ companies in particular were disproportionately in the technology, e-commerce, software outsourcing and media sectors, all of which often attract higher multiples.

Boards should obviously take a variety of other factors into account, including the availability of comparable listed stocks, an often higher proportion of retail investors in Hong Kong IPOs (resulting from the compulsory claw-back triggers there), buy-side stock coverage, aftermarket trading volumes, and ongoing listing requirements and disclosure – including pursuant to Sarbanes-Oxley legislation in the US.

But if the experience of the 2010 Chinese IPO cohort is any guide, fast-growing, high tech mid-caps may perhaps be better off seeking their fortunes in the US, where investors can better reward their business models. Just today, market sources said that Shenzhen Xunlei Network Technology Ltd., a video- and music-sharing Internet company partly owned by Google Inc., had appointed Deutsche Bank and JPMorgan as lead banks, with a view to joining social networking firm – and others – on the US IPO bandwagon. For larger issuers in more conventional industry sectors, tapping capital markets closer to home looks like a safer bet.

(Philippe Espinasse worked as an investment banker in the U.S., Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. Visit his website at Readers should be aware that Philippe may own securities related to companies he writes about, may act as a consultant to companies he mentions and may know individuals cited in his articles. To comment on this column, please email [email protected].)

[This article was originally published on Dow Jones Investment Banker on 3 March 2011 and is reproduced with permission].

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