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Special report initial public offeringS China IPOs – the era of transition After two extraordinary years

Special report

initial public offeringS

China IPOs

– the era of transition

After two extraordinary years for initial public offerings, is China equipped to continue on its path of diversifying its listing markets and attracting high levels of capital? James C. Chapman and Wanli Xu of Nixon Peabody explain the era of transition in the nation, as it moves to bolster investor confidence and encourage domestic listings.

China IPOs – the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

T he years 2006 and 2007 were extraordinary years

for initial public offerings (IPOs) by Chinese

enterprises. According to Zero2IPO Research

Center, in 2006, a total of 151 Chinese enterprises

launched their IPO’s on both domestic and overseas stock exchanges, with the aggregate amount of capital raised surging to a record high level of US$62 billion. The year 2006 was highlighted by the mega-bank IPOs. The IPO’s of Industrial and Commercial Bank of China (ICBC) and the Bank of China (BOC) together raised US $36 billion on the Hong Kong and the Shanghai Stock Exchanges. These IPOs, ranked number one and number five in the world, respectively, in terms of the largest amount of IPO funds raised in history. The year 2007 exceeded the remarkable performance of 2006 both in the amount of capital raised and in diversity of listing markets. 242 Chinese enterprises offered US $104.83 billion worth of secu- rities on the Shanghai and Shenzhen Stock Exchanges and on nine other overseas markets. Moreover, in November 2007, PetroChina’s IPO on the Shanghai Stock Exchange valued the company at approximately US$1 trillion, making it the most valuable company in the world at the time.

IPO’s remain the most appealing strategy for Chinese Enterprises

Although management buyouts and mergers and acquisitions are becoming more and more common in China, most grow- ing Chinese companies still prefer selling shares to the public through an IPO over other fund raising or exit strategies. There are many advantages to be obtained in being a publicly traded company. The trading of a company’s securi- ties over a recognised stock market provides the company’s shareholders a market to obtain liquidity for their investment. Publicly traded securities tend to yield higher share prices and thus higher valuations for the company. The company also has greater access to capital through the possibility of future stock offerings. Being publicly traded gives the com- pany ability to make acquisitions of other companies using the company’s stock as currency and ability to use stock incentive plans to attract and retain key employees. Being a public company listed on an overseas market also gives a Chinese company global visibility which is recognised by customers and strategic partners. It in turn reinforces the company’s marketplace and financial standings. Finally, pub- licly traded companies usually have a greater prestige and are held in higher regard than privately-held companies. Investors of Chinese enterprises also look to IPOs as

the preferred exit strategy. With the attractive returns on investments in China’s emerging markets, many venture capital and private equity fund investors consider China as an integral part of their investment strategy. As a result, China has become the world’s second largest foreign investment market. Venture capital (VC) and private equity (PE) firms generally view an IPO as the means of obtaining the highest returns on their investments.

“Going public is like standing in front of an X-Ray machine forever. You are completely exposed. Everything about the business is in the public domain and in front of the competition” – Anonymous CEO

The advantages of being a publicly traded company and the investors’ desire for an exit through the public stock markets have driven hundreds of Chinese enterprises to go public on both domestic and overseas stock exchanges. Chinese enterprises have become key players in the IPO markets throughout the world.

Determining whether to list on a domestic or an overseas exchange

With increases in the amount of foreign investment in China and the number of Chinese companies conducting IPO’s, most major stock exchanges are trying to become the destination of choices for these companies. In deter- mining where to go public, a Chinese company usually considers a number of factors including (1) the nature of the IPO process; (2) the annual costs of being a publicly traded company; (3) the price/earnings ratio that can be obtained and how that translates into a potential stock price and benefit to shareholders; (4) the location of the company’s customers; and (5) the potential for shareholder liquidity. For example, many domestic Chinese companies have elected to launch their IPO’s on domestic Chinese stock exchanges. The IPO process tends to be easier and less

Special report initial public offeringS expensive than in the United States. Similarly, the annual costs of

Special report

initial public offeringS

expensive than in the United States. Similarly, the annual costs of legal and regulatory compliance required of public companies is much lower in China. In addition, in 2006 and 2007, the dramatic rise of stock prices on the Shanghai and Shenzen stock exchanges provided shareholders with handsome returns on their investments. Finally, many cus- tomers were located in China or at least in Asia making an IPO in China a beneficial undertaking. Notwithstanding the above, overseas stock exchanges, particularly the New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation System (NASDAQ) in the United States, remain attractive to most Chinese companies. These exchanges have a long history with sophisticated institu- tional investors. They tend to have better liquidity and less volatility. The entire public offering infrastructure is more mature and functions at a higher level. The require- ments for full disclosure, transparency and corporate governance reduce investors’ risks and are seen by sophisticated investors as very beneficial.

The emergence of China domestic stock exchanges

Recent explosion of domestic IPO’s

In their brief history, China’s domestic stock exchanges were not initially an attractive financing option for most

Special report initial public offeringS expensive than in the United States. Similarly, the annual costs of

private Chinese enterprises. The Shanghai and Shenzen Stock Exchanges were formed in the 1990’s as arms of the Central government, not as places where sources of capital could meet users of capital in the standard equity market sense that western investors understood. The exchanges were created to list State Owned Enterprises and sell shares to outside investors thereby raising the value of the govern- ment’s stake in these companies. To date, approximately, two-thirds of the shares among domestic stock exchanges’ listed companies are owned by the state. The securities regu- latory system lacked clear rules and the enforcement mecha- nism was highly inconsistent. In addition, the investment culture was immature. Western concepts such as return on equity, price earnings ratios and the like did not command mind-share among Chinese investors. In recent years, however, Chinese domestic stock exchanges have started to become more competitive with overseas stock exchanges which have historically domi- nated world-wide capital markets. In 2007, 124 domestic Chinese IPO’s raised US$65.09 billion and averaged US$524.91 million, exceeding the 118 overseas IPO’s by Chinese enterprises which raised US$39.745 billion. Out- pacing overseas counterparts, the domestic Chinese mar- kets attracted six IPO’s with offerings of US$25.35 billion or more. Even Chinese companies backed by for- eign VC/PE had an explosive IPO growth in the domestic Chinese stock markets. Compared with the ten IPO’s listed during 2006, the 33 domestic IPO’s of VC/PE- backed companies generated a 230 percent growth rate, and yielded about twice the return of overseas IPO’s in 2007. Goldwin Science & Technology for example, debuted on the Shenzhen SME Board generated over a 30 times investment return for its investors. West Mining – the only VC/PE backed IPO on Shanghai Stock Exchange during 2007 brought its lead investor a return of 26.96 times the investment.

Regulatory efforts to improve the domestic Chinese capital markets

This explosive growth in IPOs on the domestic Chinese stock exchanges has largely resulted from Chinese government’s regulatory efforts to keep such finance transactions ‘onshore’ and to maintain ‘control’ over Chinese companies. On one hand, the Chinese government has enacted a series of measures making it much harder for Chinese com-

panies to establish offshore holding companies and dis- couraging Chinese companies from being listed on foreign stock exchanges. VC/PE financings for Chinese compa- nies have traditionally been structured offshore, using Cayman and other offshore holding companies as financ- ing vehicles. State Administration of Foreign Exchange (SAFE) Circular 75 and subsequent regulations made the use of such offshore holding companies very difficult. Similarly, historically, IPO’s of the best Chinese compa- nies have occurred in Hong Kong or the United States. This paradigm has been changed by the Regulation on Merger and Acquisition of Domestic Enterprises by For- eign Investors (the 2006 M&A Rules) which deters Chi- nese companies from restructuring for the purpose of conducting offshore offerings. These regulatory barriers make overseas listings much more difficult and the trend is to continue to limit such listings. A parallel development is the effort of the Chinese Government to implement a national strategy of building mature and multi-level capital markets. From the middle of 2005 to mid-2006, China imposed a moratorium on new domestic IPOs during which the domestic stock markets were restructured to convert non-tradeable shares into tradeable shares. Since the lifting of the moratorium, Chi- nese domestic listing activity has exploded (over 100 new listings) and until the recent correction, the domestic indexes have hit all time highs. Furthermore, recent regulations provide an incentive for more foreign investors to structure their investment vehicles as RMB dominated domestic private equity funds. The improvement of the approval process for listing on domestic stock exchanges should make it more convenient for VC/PE firms to sell their investments. Foreign private equity investors are now looking at Chinese domestic IPO’s as a possible exit rout. IDGVC, SAIF, and other investors have achieved high returns on investments on the A Share market when certain of their portfolio companies went public on the domestic A Share market. The imminent launch of China’s Growth Enterprise Market (GEM) after nearly nine years of preparation also may create additional opportunity for domestic Chinese companies. On March 21, 2007, the China’s Securities Regulatory Commission (CSRC) released Initial Public Offering and Administration Measures on Enterprises List- ing on Growth Enterprises Market (draft rules) on its web- site. The draft rules for the GEM stipulated the conditions,

China IPOs – the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

procedures for issuance, formation disclosure, supervision and other matters. Growth ventures, start-ups in high-tech parks, securities companies and their direct investment branches and various investors have been optimistic regarding the launch of the GEM. Most analysts envision that China will see a growth in domestic IPO’s after the promulgation of the final rules by the CSRC.

“Although management buyouts and mergers and acquisitions are becoming more and more common in China, most growing Chinese companies still prefer selling shares to the public through an IPO over other fund raising or exit strategies”

James C Chapman, Partner

Nixon Peabody

Apart from the GEM, the launch of an ‘over-the- counter’ (OTC) market and a market for trading corpo - rate bonds are also underway. The State Council has approved the establishment of the OTC market in Tian - jin, which will also provide more access to the capital markets for smaller private companies.

Current challenges facing Chinese stock exchanges

Although the viability of the Chinese Stock Exchanges has dramatically increased, there are still significant challenges in going public on a Chinese stock exchange. Foreign VC/PE firms still see an IPO on a Chinese domestic exchange as prob- lematic. Issuers, investors and intermediaries expect more transparency for publicly traded companies. Foreign investors still face problems with foreign exchange and significant tax challenges. In addition, current Chinese law requires investors to lock-up their shares for a significant period of time. Accord-

ingly, the Chinese stock exchanges still do not meet the needs of foreign investors which provide the majority of capital for Chinese private companies. In addition, recently the domestic Chinese stock exchanges have suffered a major correction and values have dropped 45-50 percent. As a result, the IPO activity has

Special report initial public offeringS dramatically decreased. Compared to the number and size of IPOs in

Special report

initial public offeringS

dramatically decreased. Compared to the number and size of IPOs in the first quarter of 2008, the second quar- ter appears to be dramatically down. This is especially true for VC/PE backed companies.

The use of foreign stock exchanges for Chinese IPO’s

Despite the impressive transactions that China has listed domestically in the past few years, the market value of Chi- nese companies listed on overseas stock exchanges is still larger than the market value of the companies listed on the Shanghai and Shenzhen stock exchanges. Notwithstanding the obstacles imposed by the Chinese Government, overseas IPO’s of Chinese companies continue to increase. In 2007, there were 118 IPOs of Chinese companies on overseas stock exchanges This is a substantial increase over the 2006 figure of 32 IPOs, and the 2005 number of 37. Compared with 2006, and excluding the two mega-IPO’s of the ICBC and BOC, the amount of capital raised in 2006 was substantially higher than in 2005.

The increase in competition among overseas stock exchanges

All nine major overseas capital markets attracted qualified Chi-

nese IPO’s, including NASDAQ, NYSE, Hong Kong Main Board (HKMB), Hong Kong Growth Enterprise Market (HKGEM), Singapore Exchange (SGX), Stock Exchange of Singapore Dealing and Automated Quotation Systems

(SESDAQ), London Alternative Investment Market (AIM), Taiwan Stock Exchange (TSE) and Korean Securities Dealers Automated Quotation (KOSDAQ). In 2007, the TSE, MOTH- ERS, and KOSDAQ attracted Chinese IPO’s for the first time expanding the financing venues for Chinese enterprises.

HKMB’s leading role

Due to its proximity and shared historical ties, the HKMB has been the first choice for the IPO’s of most Chinese enterprises. In 2007, HKMB continued to outpace other overseas stock exchanges both in the amounts raised and numbers of IPO’s. In 2007, 52 companies conducted IPOs on the HKMB raising an aggregate of US$31.127 billion. The large offerings in 2006 and

2007 demonstrated that HKMB had become a global player among major stock exchanges. For the first time in 2006, HKMB ranked as the number 1 exchange among world stock exchanges for total proceeds (US$46.1 billion raised).

United States stock exchanges scoring in the Chinese IPO competition

The United States stock exchanges have had the advantages of having the best liquidity and transparency, proper disclo - sure requirements, straightforward accounting rules and other positive traits. As of the end of 2006, 41 Chinese companies were listed on NASDAQ. For China venture- backed technology companies, NASDAQ is still the preferred option for an IPO. US institutional investors are very knowledgeable and are comfortable with tech -

Overseas IPO events and offer amount by market (from 2005 to 2007)

















Amt (US$M)



Amt (US$M)



Amt (US$M)



















































  • 2 127.79









  • 1 191.09









  • 5 27.09









  • 1 41.78









  • 1 31.52









  • 1 14.56











Illustration: Johnnie Au

China IPOs – the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

nology investing. Such sophistication lessens volatility and improves liquidity. The NYSE historically has been the leading stock exchange in the world and lists many

of the world’s largest companies. It has the highest list - ing standards and its corporate govern -

ance rules are the toughest. United States stock exchanges have worked hard to attract more Chinese IPO’s in the past two years. NASDAQ has Chinese-speaking staff in Shanghai and Beijing and is waiting for approval to open a Beijing office. In late 2007, the NYSE received separate approval from Chinese regulators to open a repre- sentative office in Beijing. Most Chi- nese companies looking to raise capital in overseas stock exchanges are mid- sized and looking to grow rapidly. They often find US stock exchanges as the

the vast majority of the shares of the publicly traded com- pany. The most common exchange used for this technique has been the Over-the-Counter-Bulletin Board (OTCBB). Once listed on the OTCBB, successful companies seek to build a

liquid market in their stocks and move

to a higher quality stock exchange such as NASDAQ. Over the past five years, There has been a tremendous resur- gence in reverse mergers in the US as institutional investors began investing in companies that become public through reverse mergers. The SPAC is a company with no assets or business that conducts an IPO. Investors are willing to pur- chase the shares of the SPAC based upon the reputations of the founders of the SPAC and its purpose. Once the IPO is completed and funds raised, the SPAC seeks to purchase an operating business. Currently, there are a number of SPACs which

Wanli Xu

Nixon Peabody

“Many domestic Chinese companies have elected to launch their IPO’s on domestic Chinese stock exchanges. The IPO process tends to be easier and less expensive than in the United States”

best alternative for not only attracting US capital but global capital as well. Whether it is because of the size and reach of the NYSE or the expertise with technology companies possessed by NASDAQ, US exchanges are often being selected for IPO’s over other foreign alternatives. Outside forces have also driven Chinese companies to US stock exchanges. Many institutional investors prefer a listing on the US stock exchanges. Mainland firms hope that listing in a market known for tough regulations and strin- gent oversight will give them credibility with both global and domestic customers and business partners.

IPO Alternatives in the US Capital Market

The US stock markets have not only been successful at attracting Chinese companies interested in IPOs, but they have had success in attracting Chinese companies interested in alternative methods of going public. Currently, there are two major IPO alternatives available in the US. These include the ‘reverse takeover’ or ‘reverse merger’ and the special purpose acquisition company or ‘SPAC’ as it is com- monly referred. A reverse merger is a transaction in which an operating company mergers with a publicly traded corporation that has no business. By means of a share exchange or merger, the shareholders of the operating company end up owning

have been formed to acquire pri - vately held companies located in China. The acquisition is usually completed as a share exchange and the holders of the Chinese company end up owning shares of the publicly traded company.


The Chinese domestic stock exchanges have matured greatly in the past three years. Regulatory reforms, the intro- duction of new products and the Chinese Government’s efforts to discourage IPO’s on foreign exchanges, have all bolstered the Chinese stock exchanges. Overseas stock exchanges continue to attract Chinese companies with better liquidity and a more mature investment culture. Each of the stock exchanges discussed in this articles have advan- tages and disadvantages. In this era of transition, Chinese companies should carefully evaluate the best exchange for their IPO’s and plan far in advance. Careful analysis and thoughtful planning can make the difference between a hugely successful IPO and failure.