Stocks soared on the first trading day at the new STAR market for technology companies at the Shanghai Stock Exchange yesterday. Three new billionaire clans were created (see link here), adding anew to their numbers in a country that ranks second only to the United States as home to that group.
What will be the impact of the STAR market for the New York Stock Exchange and Nasdaq as a listing destination for up-and-coming Chinese tech companies? How does the arrival of this new financing channel for Chinese businesses fit into the current overall landscape of deteriorating U.S.-China relations?
To learn more, I exchanged by email today with Drew Bernstein, co-managing partner at accounting and advisory firm Marcum Bernstein & Pinchuk.
Q. China launched its STAR market on Monday. What are the implications for the NYSE and Nasdaq, who have been working to attract Chinese companies to trade there? Is this a new rival? Will Shanghai’s STAR market replace New York and Hong Kong as the listing destination of choice for China’s tech unicorns?
A. Chinese companies have a range of options when it comes to where to list these days, which is great news. The opening day performance of the first round of STAR IPOs was impressive, and CEOs and private equity firms will undoubtedly be watching carefully to see if those heady valuations of the first day can be sustained. A pipeline of 140 companies have reportedly already filed to list.
But the STAR market may not be right for all of China’s tech unicorns. An overseas listing offers many advantages that are not available in China, including the ability to tap billions of dollars of institutional capital, the flexibility to do multiple equity and debt offerings over time, and the liquidity for founders and private equity sponsors to sell part of their holdings while not being subject to currency controls. For all these reasons, STAR may not be the first choice for China’s largest and most high-profile tech companies to go public.
Q. How does the overall deterioration in U.S.-China relations factor into this? Some even say the U.S. shouldn’t be financing Chinese IPOs.
A. The STAR market may be a mechanism to bring badly needed growth capital to earlier stage technology companies that are aligned with China’s industrial policy aims. Just as importantly, it provides a venue to test market-based approaches to capital allocation and price discovery that may be expanded more broadly in the future.
Despite trade tensions, the love affair between Chinese tech companies and U.S. investors burns bright because each is drawn to something they are not finding at home. There are more than 300 unicorn companies worldwide, and more than 180 of them come from Chinese. All of these growing, innovative Chinese companies will need capital as they continue to evolve. American investors swoon over the eye-popping revenue growth of Chinese companies and covet access to a market with users measured in billions that is not yet saturated, where new business models proliferate rapidly. A U.S. listing provides the opportunity to tap into billions of institutional capital and a deep bench of highly specialized technology investors and analysts. That said, it is also the most demanding market from a disclosure and activism perspective. In speaking with Chinese CEOs and founders, the conversation is about weighing the advantages and risks that each market provides.
Q. In general, how much regulatory risk for U.S. investors is there with Chinese IPOs? Even investors in Hong Kong-listed have been burned by abuse.
A. This issue is not going away. With the increased weighting of China in MSCI indexes, international institutions are going to be bigger players in China’s domestic markets. So, the solution is that companies and investors need to both up their game. As an auditor, I can tell you that working with Chinese companies requires an additional level of care and local knowledge to manage risk. Applying plain vanilla audit procedures is not going to be sufficient in a legal and business culture that is still maturing. We also spend a lot of time educating our clients about the expectations around governance and disclosure that come along with having an international shareholder base. I actually see it as an opportunity, since if a Chinese company goes the extra mile to be very clear about its strategy and business decisions and invests in quality financial reporting, then that really stands out. If you can combine China growth and world-class management and reporting, that is going to be a company that investors want to own.
—Follow me @rflannerychina