The current tech boom on the public markets has been very different from the dot-com bubble, but a group of Chinese imports is changing that.
U.S. tech companies that have made it to Wall Street in the past few years typically had been operating for 10 years and so, as compared with the companies going public in the late 1990s, had more financial information to show investors. But this year, a slew of young Chinese tech companies have gone public or have plans to tap the U.S. markets, and they are a motley crew that includes some of the scary types of investments that caused the dot-com bust two decades ago.
About 12 Chinese companies have raised a total of over $5.5 billion in U.S. stock-market debuts this year, according to data compiled from IPO Boutique, MarketWatch and company press releases. Most of them are not even public in their home country, which has instituted tighter regulatory constraints on going public, and many have very brief operating histories.
The companies include clones of established U.S. tech companies, which are largely shut out of the China market, and can be so ridiculous that the list could be read by the Pets.com sock puppet and be taken just as seriously. Take, for example, Pinduoduo Inc.
PDD, +1.65%
, a two-year-old app for group-buying discounts that has been described as a cross between Groupon
GRPN, -4.80%
and Facebook
FB, -2.78%
, yet was oddly sold in IPO paperwork as a mash-up of Costco
COST, +0.45%
and Disneyland. It raised a whopping $1.63 billion, and currently has a market cap of more than $20 billion, almost ten times Groupon’s valuation.
IQiyi Inc.
IQ, -0.59%
, a unit of Baidu that is referred to as the Netflix
NFLX, +1.55%
of China, is among the senior citizens of the bunch, as it was founded in 2010, and had the biggest deal of them all this year, raising $2.25 billion. Huami Corp.
HMI, -2.79%
, founded in 2014 and often referred to as the Fitbit
FIT, -0.68%
of China, raised $110 million in February; Uxin Ltd.
UXIN, -1.84%
, a nearly seven-year-old company that is the largest platform in China to buy used cars, raised $225 million.Mobile game and live broadcasting app BiliBili Inc.
BILI, +0.09%
, a 10-year-old company that seeks to “enrich the everyday life of young generations in China” with anime and comics themes and games like “Fate/Grand Order,” raised $483 million in March, a couple of months before its app was removed from some app stores in China for a month by the Chinese government.
Deals expected to come soon include a four-year-old electric-car rival to Tesla Inc.
TSLA, +0.07%
called Nio Inc.
NIO, +0.00%
, which plans to raise $1.8 billion, and a two-year-old content-aggregation app called Qutoutiao Inc.
QTT, +0.00%
, whose name translates to “fun headlines” and is looking to raise $300 million. The biggest Chinese deal of the year is expected to be Tencent Music, the music subsidiary of Tencent Holdings
TCEHY, +0.24%
, which confirmed that it is aiming for a late September IPO and seeking to raise between $3 billion and $4 billion in that deal.
Just as in Silicon Valley’s 1990s boom times, these companies’ minuscule operating histories are themselves appealing to some investors. Such investors are looking to invest early in a young company’s growth cycle and have not had access to U.S. companies at such stages. As capital has been readily available in the private markets, U.S. companies have waited longer and longer to go public, far longer than the typical IPOs of the dot-com boom.
Read: How the government tried to encourage IPOs, but instead helped create the Age of the Unicorn
Also see: SEC’s Clayton mulls allowing mom-and-pop investors to play VC with pre-IPO companies
“Chinese companies going public earlier in their life cycle have an opportunity to fill that void,” said Rohit Kulkarni, managing director of private investment research for SharesPost Research LLC, told MarketWatch, adding that there is an “appetite for growth” among public investors. “Earlier in the life cycle, people don’t know if the growth rate will accelerate or decelerate, but, if you’re willing to bet that there is an accelerating moment of growth, you can catch the part of the S curve where you have acceleration and an explosion of value.”
Of course, grasping for revenue growth at unprofitable and unproven tech companies en masse is exactly how the dot-com bust roiled Wall Street nearly 20 years ago. These Chinese companies, however, could be even more dangerous due to convoluted corporate structures that one attorney has said create “a 100% level of risk.”
Chinese laws prohibit foreign ownership in certain industries, including telecommunications and the internet, so the companies adopt structures known as variable interest entities, or VIEs. These structures make these companies as potentially risky as the most wobbly of the c. 2000 investments, with little to no shareholder rights on offer.
It was actually in 2000 that VIEs first appeared, in the form of the Sina Corp.
SINA, -0.09%
IPO — Sina being China’s version of Twitter. The VIEs take various forms, with some far more complex than others. But the bottom line is that investors are not buying shares in a company or its operations in China. Instead, they are buying shares in a shell company incorporated elsewhere, often in the Cayman Islands. This shell or holding company owns a wholly foreign-owned enterprise, or WFOE, that funnels capital from foreign investors back to the Chinese entity.
“Compounding the structure’s complexity, the ListCo is generally a holding company that bears the same name as the Chinese VIE, obscuring the reality that investors purchase depositary shares of a shell company with a third-tier relationship to the lucrative VIE,” said the Council of Institutional Investors in a report in late 2017 on Chinese VIEs called “Buyer Beware: Chinese Companies and the VIE Structure.”
So far, in the recent batch of Chinese IPOs, all of the tech-focused companies have had this structure. In addition, mirroring Silicon Valley’s obsession with founder-controlled companies, the shell company itself is often controlled by the top executives or founders of the original Chinese company.
“It’s a double whammy. If you are a U.S. investor, you really have no say in anything that has to do with the company,” said Brandon Whitehill, a research analyst at the Council of Institutional Investors and author of the report. “We put out the report to educate people, because if you don’t understand the mechanics [then] you have no business investing in these glamorous Chinese IPOs. It can be a governance risk, [and] it can be a financial risk.”
He also noted that while the companies must prepare quarterly financial statements, there are no annual-meeting requirements or standards for board independence for companies based in the Cayman Islands or the British Virgin Islands. Another point is that U.S. auditors would not have access to the company’s so called backroom records, which are used to compile financial statements.
“The Chinese, being opaque and capricious, have designated the paperwork as state secrets,” Whitehill said, adding that this factor has been a major sore point.
Investors buying shares in the shell companies can only hope that the shares themselves appreciate in value and not count on dividends, shareholder buybacks or other investor returns.
Steve Dickinson, a lawyer with Harris Bricken in Seattle who specializes in working with foreign companies operating in China, said that investors in the holding companies in the Cayman Islands will eventually tire of the situation, under which all the cash is sent to China, and will demand returns. But, he said, any such attempts by investors to seek funds from the so-called WFOE will be unsuccessful.
“In terms of investment, there is not one single Chinese entity that is listed outside of China in ADR or on the H.K. [Hong Kong] exchange that has a clean, legitimate set of books. Investment in any Chinese entity is therefore made at a 100% level of risk,” Dickinson said, adding that he would not even call these vehicles an “investment.”
Since the structure of the shell company sought to sidestep Chinese law in the first place, contracts between a foreign entity and the shell company are unenforceable, he explained.
The Securities and Exchange Commission seems interested in ensuring that the Chinese companies fully disclose the VIE structure and its results, at minimum. “Since investors will be investing in a holding company that does not directly own its operations in China, please make this fact clear in your prospectus summary,” the SEC wrote to Pinduoduo in a June 5 letter, as it was reviewing the company’s documents. “It must be clear that the business you are describing is not the registrant’s business.”
More from Therese Poletti: ‘Disrupted’ shows tech hasn’t learned lesson from dot-com bust
MarketWatch reached out to the Chinese companies in question to discuss the existing investor concerns, and heard back from only two — yet another worrisome sign. A spokeswoman for Nio said the electric-car company is in a quiet period ahead of its IPO, and a Pinduoduo spokesman defended the company’s structure in an emailed statement.
“VIE structure has been a structure commonly adopted by U.S.-listed companies with principal business in China that is subject to foreign investment restriction,” he said. “The first batch of Chinese companies with VIE structure were listed on U.S. stock exchanges in early 2000s, i.e. more than 15 years ago. The VIE structure has been refined over the years giving more protection to shareholders. We believe the market is well informed of the rationale of the VIE structure.”
He also added that a dual-class structure is common among tech companies, mimicking the rationale offered by Google
GOOG, -1.27%
GOOGL, -1.26%
, Facebook, Snap
SNAP, -3.07%
and other tech companies that have two classes of stock. Often the share class conferring outsized voting power is controlled by a founder or founders and other early investors.
For more: Backlash won’t stop founder-friendly stock structures
“The structure allows us to focus more on our long-term vision without being influenced too much by short-term results,” the spokesman said.
Shares of Pinduoduo have been extremely volatile since the company’s ultimately successful debut in late July. The stock tumbled last week to trade below its IPO price after the company was hit with at least three shareholder lawsuits alleging that Pinduoduo was doing an inadequate job of preventing the sale of counterfeit goods on its platform, and therefore its revenue figures and active-merchant count were due in part to unlawful conduct and not sustainable.
The spokesman said the company believes the lawsuits have no merit. “We have been working diligently to eliminate the sale of counterfeit goods,” he said.
Shares of the other Chinese companies have had mixed performances. Bilibili is up about 12% from its IPO price, while Huami is off nearly 11%. Uxin, the marketplace for used cars, has tumbled nearly 39% since its IPO. These stocks definitely are not for the faint of heart.
Just as Google and Amazon.com Inc.
AMZN, -1.83%
emerged from the dot-com meltdown and became tech-sector stalwarts, it cannot be ruled out that a handful of the Chinese companies could become similarly successful. But more are likely to disappear, along with the money invested in them. Just as in the dot-com bust.
MarketWatch reporter Emily Bary contributed to this column.
Want news about Asia delivered to your inbox? Subscribe to MarketWatch’s free Asia Daily newsletter. Sign up here.
Source : MTV
