Unwind the VIE and go home | China Accounting Blog | Paul Gillis

Unwind the VIE and go home

There is a interesting editorial in Caixin today. It was written by Wang Rao, CEO of Chinese investment bank e-Capital. Wang argues it is time for overseas listed Chinese companies to unwind their VIE structures and seek listing at home. The editorial comes on the heels of an announcement that Chinese investment manager Shengjing had launched an investment fund dedicated to helping overseas-listed Chinese to delist and list instead on China’s stock exchanges. I have long argued that Chinese markets are the appropriate place for Chinese companies to list, since Chinese investors and regulators are better able to understand the companies. The Chinese stock markets, however, have not developed sufficiently for this to happen, I had forecast it would take 5-10 for the necessary reforms to make domestication possible. It appears that things may be moving faster than I expected.

The main factor driving this thinking is the rapid development of China’s own stock markets. The China Stock Market (SSE Composite) has more than doubled in the last year. Perhaps even more important is the success of China’s new third board, the National Equities Exchange and Quotations (NEEQ). NEEQ listed an average of 193 companies a month for the last four months, and now lists 2,343 companies with a total market cap of over US$180 billion. These are mostly small companies with an average market cap of only $77 million. Regulators have promised to tighten supervision of this lightly regulated market, and time will tell whether this market will be plagued with the rash of frauds that were seen with US reverse mergers on the US OTCBB. 

By contrast, only two Chinese companies have listed on US exchanges this year. Wowo Ltd listed on NASDAQ in April at just over $11 and now trades at just over $8. Alibaba backed Baozun managed to raise $110 million in a NASDAQ listing that saw the offering price slashed before launch. Baozun managed to climb 4.6% on the first day. US investors are not giving the frothy values that Chinese stocks are getting on their own exchanges. Perhaps Alibaba sucked all the oxygen out of the room, and no other Chinese company can get attention. I am not ready to declare the US markets dead for Chinese companies, but the deathwatch may have started. 

The idea of delisting Chinese companies from US exchanges and relisting in China is not a new one. Focus Media went private in 2013 at a price of $3.87 billion and hopes to relist in China through a reverse merger this autumn at a much higher price. Focus Media’s valuation had been slashed by Muddy Water’s allegations of fraud. A reverse merger will avoid, or at least delay, Chinese regulatory scrutiny of a new IPO.

Wang points out in his editorial that unwinding VIE structures, particularly in restricted industries, may not be easy. VIEs are not permitted in domestic listings, so the structures must be unwound if the companies are to be listed in China. In restricted industries like e-commerce, foreign investors will have to be removed, unless the proposed foreign investment reforms allow non-controlling foreign ownership.  Wang seems to think such reforms, while likely, are at least one and half to two years out. 

Foreign investors will be rightfully concerned that they may be forced out of their investment in US listed Chinese companies at below fair value. Cayman Islands law (which applies to most of these companies) provides little protection to minority shareholders in a going private transaction. At present, foreign shareholders have limited opportunity to invest in China’s stock exchanges, although that is also changing rapidly.

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