The vibrant market for Chinese IPOs in the United States was somewhat surprising given escalating trade tensions between the United States and China during 2018. However, for many Chinese tech firms, there are compelling reasons for doing an IPO in the United States, as opposed to Hong Kong or Shanghai. For a start, 2018 was a bad year for Chinese stock markets. The Shanghai Stock Exchange ended the year down 25 percent, its worst annual performance since 2008, while the Hong Kong Hang Seng market fell about 14 percent. The drop in the Chinese markets was precipitated both by the simmering trade war with the United States and slowing economic growth in the country.
Against this background, Chinese investors had a diminished appetite for technology IPOs, which are often seen as riskier than the IPOs for more established enterprises. In the United States, by contrast, there was a strong appetite for investing in Chinese tech IPOs, with many investors seeing this as a way to participate in China’s enormous domestic market and vibrant long-term growth prospects, particularly in technology, as the country’s living standards continue to rise. The United States is also home to more large institutional investors, some of whom seek to channel a small portion of their funds into risky ventures, with hopes of scoring large gains. Thus, the supply of capital for high-risk tech IPOs was greater in the United States than in China.
Another factor is that stock market regulations make it easier for founders to retain control of their enterprises after IPOs in the United States. American exchanges have long allowed for dual class shares, in which founders maintain control of class A shares that give them super voting rights, while raising capital from the sale of class B shares that have limited or no voting rights. Moreover, American exchanges allow IPOs for enterprises that have yet to generate revenues, such as research-stage biotech companies, whereas Chinese exchanges have historically not allowed that. In 2018, in response to the advantages enjoyed by American exchanges, Hong Kong changed its listing standards to allow for dual class shares and opened the doors to biotech firms that have yet to generate revenues.
A risk associated with investing in Chinese IPOs offered through American exchanges is that, in addition to dual class shareholdings, they also can have complex ownership structures. The typical Chinese IPO uses variable interest entities (VIEs). This is a structure in which the Chinese company creates two entities: one in China that holds the permits and licenses needed to do business there; and the other an offshore entity, often in a tax haven such as the Cayman Islands, in which foreign investors can buy shares through an IPO. The Chinese entity, which is usually owned by top executives, pays fees and royalties to the offshore company in contractual arrangements. The risk here is that foreign investors don’t actually own stock in the Chinese domicile company, and local management or even the Chinese government could force a split with the listed company, leaving U.S. investors high and dry. As the prospectus for Chinese IPOs often warns investors, “you may face difficulties protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.”*
These risks, however, have not deterred U.S. investors.
All this being said, Hong Kong still dominated the market for Chinese IPOs in 2018, with 76 new offerings, a record number, that generated proceeds of $31 billion.
This included China Tower, a state-owned company that is the world’s largest operator of telecommunications towers.
China Tower has 1.9 million tower sites, has 2.8 million tenets in China, and rents out capacity on its towers to mobile phone carriers. The company raised $6.9 billion in its Hong Kong IPO, making it the world’s largest listing in 2018. It will use the proceeds to build new towers and upgrade existing ones as it accelerates its rollout of fifthgeneration (5G) network capabilities.
Case Discussion Questions 1. What are the advantages to Chinese firms of listing IPOs on stock exchanges located in the United States?
2. Why do American investors want to invest in the IPOs of Chinese enterprises? What is the potential upside here? What are the risks? Is the potential return sufficient to compensate for the risks?
3. Is the ability to offer an IPO in the United States good for the Chinese economy? Is it good for the American economy?
4. In late 2020, then-President Trump signed an executive order that banned Americans from investing in companies that were connected to the Chinese military. In response, the New York Stock Exchange said it would delist three large Chinese telecommunications service providers: China Telecom Corp.
Limited, China Mobile Limited, and China Unicom Hong Kong Limited. How do you think this action will impact Chinese IPOs on American stock exchanges going forward? What are the implications for the efficiency of the global capital market?