[From the Archives] Exit Barriers for U.S.-Listed Chinese Stocks: Chinese companies, some of which stung by accounting scandals on U.S. stock markets, are now struggling to privatize, delist and move on


01.21.2012 15:30

Exit Barriers for U.S.-Listed Chinese Stocks: Chinese companies, some of which stung by accounting scandals on U.S. stock markets, are now struggling to privatize, delist and move on

By staff reporters Huo Kan in New York and Zhang Tao in WashingtonJinan-based software developer Pansoft Co. Ltd. says it’s going private, climbing aboard an increasingly crowded life raft as Chinese companies abandon U.S. stock investors. As of mid-January, some 20 of the 230 Chinese companies with stock traded on the New York or Nasdaq exchanges had announced privatization plans. At least eight in the group had completed the process. The privatization push, expected to accelerate in 2012, stands in stark contrast to the scene in early 2011 when Chinese companies were frantically competing to list on U.S. stock markets. That was before accounting scandals and short-sellers hammered a few high-profile companies, damaging the image of Chinese concept stocks overall.Share prices plunged across-the-board last year based on negative reports about accounting practices at companies such as Orient Paper Inc. and Focus Media Holding Ltd. Short-seller Muddy Waters’ critical analysis of Toronto-listed Sino-Forest Corp. also contributed to Chinese concept stock sell-offs by U.S. investors.

By the end of 2011, trading had slowed to a trickle. About 65 percent of U.S.-listed Chinese companies saw average daily transaction volumes fall to less than 100,000 shares. Some small companies have even found it impossible to raise capital for stock market-related costs.

Interest in Chinese initial public offerings has withered as well. Online video company Tudou Holdings Ltd.’s stock debut on Nasdaq in August may have been the last new Chinese concept to launch an IPO on a U.S. bourse for a long time.

Many companies have thus turned to privatization as their most viable bailout option.

In many cases, the privatization route begins when a top executive, founder and/or management team drafts a buyout plan with a private equity fund. Together they raise cash and buy at least 90 percent of circulating shares through a direct acquisition or tender offer before delisting from the stock market.

According to documents filed with the U.S. Securities and Exchange Commission (SEC), a British Virgin Islands-based company represented by Pansoft Chairman Wang Hu plans to buy all of the company’s outstanding U.S.-listed stock for US$ 3.76 a share.

Pansoft’s Nasdaq stock price jumped on the buyout news in early January after bottoming last fall around US$ 1.6 a share.

Choppy Seas

Privatization is not uncommon for any company that decides to exit a U.S. capital market, said Scott Cutler, a vice president at NYSE Euronext. Indeed, he said, dozens of companies typically privatize and delist every year.

Most companies initially go public to raise money and create value for existing shareholders, said Bruce Jackson, CEO of the New York-based investment bank Carver Cross Securities. When neither goal is attainable, he said, privatization makes sense.

Jackson, who helped a Chinese company delist from NYSE, predicted “privatization will be the big trend” in the coming year as all sorts of companies abandon stock markets.

U.S.-listed Chinese companies saw stock-listing goals quickly sink beyond reach last year in the negative publicity surrounding SEC investigations and investor class action lawsuits against a few Chinese concerns.

Charges of accounting frauds against a Hebei Province-based paper manufacturer Orient Paper, Inc, for example, sent that company’s American Exchange-listed stock tumbling to U.S.$ 4.35 a share in July 2010, down nearly 50 percent from a week earlier. The company’s price-earnings ratio has fallen to a paltry 2.78.

Investors punished the entire class of Chinese company stocks in the wake of the Orient Paper charges, which company officials have denied.

Some Chinese companies listed in the United States for the wrong reasons, such as status, said Pan Xichun of the American law firm Goodwin Procter. In the process, they failed to properly weigh costs and benefits. Only later did they find listing-maintenance costs not worth the amount initially raised.

For these companies “delisting may be the better way,” Pan said. “Right now, the capital market is dealing a serious blow to business. They cannot even concentrate on their normal business.”

But the privatization life raft is not without risk – and it can be expensive.

To privatize, a company must subject its financial data, assets and transactions to microscopic reviews by private equity funds, shareholders and the SEC. Common shares must be purchased with cash, which forces many companies to ask a third party such as a bank for money.

However, Li Junheng, an analyst at the New York-based equity research firm JL Warren Capital, said many private equity funds in recent weeks have decided to take a wait-and-see attitude toward privatization projects in hopes stock prices for target companies, including Chinese concepts, will continue to fall in coming months.

A source at a New York branch of a Chinese state-owned bank told Caixin her bank is unlikely to participate in or provide loans for any U.S.-listed company’s privatization and delisting project. “It’s too risky,” she said. “There’s too much uncertainty.”

Pan said a company that seeks a stock market exit through a tender offer may clash with shareholders seeking a higher offer, sparking one or more lawsuits. A merger-based exit strategy requires meetings of the board of directors and shareholders, which slows the process – and may derail it.

Chen Hua, managing director of a New York-based consultancy Urbach Hacker Young International, said a delisting can take two years. Throughout that period, a company must follow SEC rules by submitting financial documents including annual and quarterly reports.

Coming Home

Chinese companies that abandon U.S. markets may find new investors closer to home on the Shanghai, Shenzhen or Hong Kong exchanges.

So far, none of the Chinese companies that successfully delisted from American markets have launched IPOs in Hong Kong or the mainland.

But Hou Yongjin, a partner at SC Global Consulting, said it’s feasible for a profitable company with positive cash flow to obtain a higher valuation after privatization by launching an IPO in China.

Mainland and Hong Kong investors are more familiar with Chinese business and companies than Americans, and thus are in a better position to set the true value of Chinese concept stocks. Moreover, fund-raisers may be larger at home than on U.S. exchanges, and PE ratios higher.

September markets data compiled by the Beijing-based Jun He Law Offices said the average price-earnings ratios was 23.1 for companies listed on the Shanghai market, 40 for Shenzhen-listed firms and 44.8 for those on the ChiNext board. Most of the 230 Chinese companies listed in the United States reported PE ratios of less than 10, and ratios for only 53 exceeded 10.

Another complication for any Chinese company seeking a domestic listing after exiting a U.S. market, Hou said, is that under the law Chinese nationals must control at least 51 percent of any mainland company. That means many switching from a U.S. to a Chinese bourse would have to change the offshore-shell company structures used to meet U.S. listing regulations.

Not all Chinese concept stock companies are willing to return to China. Xu Liang, financial chief at the large film distributor Bona Film Group, said he’d rather stay on the U.S. stock market than accept the higher regulatory costs and stiffer constraints associated with a mainland listing.

“Even if there is future privatization and move to the domestic market, Bona will definitely not be the first to go,” Xu said. “We would certainly let others go first, let others prove the model. When it is acceptable from a legal perspective and to American investors, then we’ll go.”

And while memories of the 2011 accounting scandals have faded in recent weeks, share prices for some U.S.-listed Chinese companies have rebounded. Some analysts say the negative publicity may have weeded out problematic companies and left quality stocks behind.

U.S.-listed shares of Chinese companies such as Focus Media and private educational service provider New Oriental Education & Technology Group have been slowly recovering recently in what may reflect a maturing process for Chinese companies, especially those that accept the ups and downs of foreign capital markets.


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