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| JULY 30, 2012


Bringing unloved Chinese companies home


n early April, Fushi Copperweld, a Nasdaq-listed Beijingbased manufacturer of copper wire and cable from welded aluminium and steel, came under severe attack by short-sellers. The sell-off in its shares, following the publication of a scathing report by Muddy Waters, the independent research firm headed by Carson Block that brought down Torontobased timber firm Sino-Forest Corp in a fairly similar fashion last year, seemed ominous. Muddy Waters alleged that Fushi had overstated production 13-fold and was possibly falsifying financial statements a statement Fushi vehemently denied. It seemed only a matter of time before the company would go down the well-trodden path of listed North American Chinese concept plays that had been the targets of similar attacks. Yet, three months on, Fushis stock, which had plunged 40% to a low of US$5.81 in April, has rebounded. On July 23, it touched a record high of US$8.98 higher than where it was before the attacks began. Whats going on? Well, for one thing, Fushis chairman and CEO Li Fu is taking the firm private for a whopping US$9.50 a share with the help of private-equity partners. Lending a helping hand is state-owned China Development Bank Corp (CDB), which has set aside more than US$1 billion ($1.25 billion) to help bring Chinese companies listed overseas home. The stocks of Chinese companies listed in the US, Canada, Australia and London and, indeed, even Schips in Singapore have been battered over the past several years, following revelations of accounting and corporate-governance scandals. Attacks by short-sellers such as Muddy Waters Block have decimated Chinese concept stocks, which had become one of the hottest asset classes in the world. Over the past two years, US-listed Chinese concept stocks are down nearly 60%. Reverse takeover (RTO) stocks, which involves Chinese companies taking over shell listed firms overseas, thrived from 2006 to early 2011, when for the most part the IPO markets in the US and Europe were in the doldrums and there was too much money chasing pie-in-the sky China stories. Chinese concept stocks came in and totally rejuvenated the market, recalls Robert Koepp, author of Betting on China: Chinese Stocks, American Stock Markets, and the Wagers on a New Dynamic in Global Capitalism. Unfortunately, the RTO stocks somehow escaped the scrutiny that accompanies such takeovers.

Slipping through the cracks

Koepp says over the last six years, many decent Chinese companies with business models as good as any in the world listed on the Nasdaq or the New York Stock Exchange, but there were others that should never have listed anywhere that slipped through the cracks. With low growth, low interest rates and choppy markets,

The problem was that too many Chinese companies that were just not ready for a public listing or the scrutiny that comes with it went public. Some were just not cut out to be publicly listed or didnt have the desire to adhere to the rules that govern listed companies, Koepp says. Such firms should just either borrow from the bank or get privateequity investors and remain private. The beauty of capitalism is that if a company is not being recognised by the public via a listing, some smart private-equity guy can come in and help. Chinese companies that are growing and have a good business model will always find investors because China is the worlds second-largest economy and one of the fastest growing, Koepp says. He adds that global investors need to be in China to partake of its growth and they will throng to good companies, whether Koepp: For SMEs, the use of RTOs as a practical means to raise funds is now gone they are listed or not. To be sure, China wants a worldthe desire to find high-growth com- er, you should have a lot more goclass capital market that can help panies that promised better returns ing for yourself to convince sceptifund the needs of its growing comcaused regulators to let down their cal investors, he says. While thats not necessarily a bad panies over the next several decguard and not apply caveat emptor the ades. Chinese companies need to way they should have, he tells The thing for the market, it clearly closbe organised and run in a way that Edge Singapore in a recent interview. es an avenue that Chinese compaglobal finance can support them, Investors assumed that if the com- nies had until recently. Still, Koepp Koepp says. China needs a better panies were listed on US exchanges, says smaller private Chinese comparegulatory regime, stricter accountthey had been vetted by someone nies will continue to have access to ing rules and rigorous auditing to investment banks, regulators, law- other sources such as private equity. Until now, private-equity firms help build investor confidence, and yers but they werent. capital will follow. In recent months, the US Secu- in China had too much money and Just last week, Chinese investrities and Exchange Commission were chasing too few companies, he ment banking giant CITIC Securities (SEC) and exchanges such as the notes. As RTOs and other financing agreed to buy Hong Kong-based inNasdaq and NYSE have moved to avenues are closed to some of these dependent regional investment bank plug loopholes and tighten rules in a SMEs, they will look to private-eqCLSA Emerging Markets for US$1.2 way that could see a lot of small and uity investors. What happens next for Chinese billion. CLSA is such a unique freemedium-sized Chinese RTO compathinking iconic asset that it will nies de-list over time. There is cer- SMEs? With the Shanghai and really add a lot of value to a tainly very strong reappraisal going Shenzhen markets in the dolChinese institution like CITIC on in the US in the aftermath of the drums, it is hard for third- and Securities, says Koepp. RTO scam, Koepp notes. Clearly, fourth-tier firms to list in ChiThe purchase is a sign of there were a number of companies na. Hong Kong, Canada, Austhe times. Chinese companies that really shouldnt have listed that tralia and Singapore have either expanding overseas need ineventually bore the brunt of attacks tightened or are in the process vestment banks to help them by short-sellers like Muddy Waters, of tightening their listing rules. grow and do mergers and acgiving some of the legitimate, better- Moreover, Chinese banks arent quisitions. There is also a huge run Chinese firms in the US a bad eager to lend to such companies, and growing pool of Chinese name and resulting in a sell-off in which are finding it difficult to capital that needs to deployed Chinese listings. The upshot of the raise funds anywhere. If fundoverseas. On July 16, short-sellsell-off is that smaller Chinese com- ing for small enterprises in Chiers unleashed their wrath on panies in the US need to reassess na is choked off, it doesnt bode yet another US RTO firm, New whether they can stand further reg- well for the mainlands econoOriental Education, whose ulatory heat and costs or just pack my, which has begun to slow in recent months. Consensus stock plummeted more than their bags and go home. 50% in the aftermath. But for For SMEs [small and medium- economic forecasts for China now, few are rushing to help sized enterprises], the use of RTOs are now just above 7% for this the Chinese private-education as a practical means to raise funds year, the lowest in years. firm come back home. The deis now gone, concedes Koepp. No listing of RTO stocks will help bourse in the world, whether it is Tackling the core issues close a turbulent chapter in the Singapore Exchange, Nasdaq or The way Koepp sees it, despite Chinese corporate history and the ASX, is still willing to roll out the reputational setbacks in the measures such as the CLSA purthe red carpet for Chinese concept wake of some RTO scams and Chinese Stocks, American Stock Markets, and the chase last week will mark the stocks. If you are going to the US other accounting issues plaguing Wagers on a New Dynamic in Global Capitalism E start of a new chapter. market as a small- or mid-cap issu- Chinese companies listed over-

seas, regulators and corporates can quickly turn things around. The core issues are still management, corporate governance and truthful accounting, he says. Moreover, he notes that it was not just the Chinese companies that were at fault in many of the publicised cases. Some of the short-sellers took advantage of the situation and there have been disruptions from disreputable intermediaries as well. If the net result of what has happened over the past two years is to encourage Chinese entrepreneurs to find ways to improve management structures so they can attract highquality private equity at the growth stage and global-quality public equity at the mezzanine and later stages, we will have a stronger Chinese corporate sector. Aside from helping Fushi, CDB plans to privatise and de-list other smaller Chinese companies whose shares have plunged in the past year since the unfolding of the Sino-Forest saga. Other Chinese financial institutions, including China CITIC Bank, have also said they are ready to step in to help privatise Chinese companies listed overseas, including S-chips in Singapore, that are tarred with the same brush as that of the fraudulent RTO firms. Beijing is willing to provide more funds to help privatise some of the better-run SMEs listed overseas, though many of the firms dont want to take additional loans to go private first, then wait years in the IPO queue to raise funds to pay off those loans. There are some good Chinese companies that havent been well received overseas, notes Koepp. Yet, clearly, there is merit in helping to privatise these companies and then re-list them in Shanghai, Shenzhen or even Hong Kong. Chinese companies that are suffering on US exchanges but have viable business plans still have some options, Koepp says. They can take the necessary steps such as putting in place better corporate governance, reporting mechanisms and communication strategies, which may not be all that difficult.

Indeed, for many battered companies, it is possible to rebuild their market capitalisation over time. A well-run listed Chinese company on the Nasdaq or NYSE can use its visibility to its advantage, Koepp points out. For companies that are serious about going global and are at the cutting-edge of technology or best in their chosen field, an overseas listing makes a lot of sense.

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