China’s buyouts - home is now where the money is
- The lure of the US listing is beginning to pale for Chinese firms
- Beijing proved it would always prop up equity markets to stop social unrest
- Qihoo’s bid to to privatise may be 'helped' by the Chinese government
By Neil Flynn
As the domestic Chinese equity markets were reaching their peaks, US-listed Chinese firms began to announce privatisation bids.
The two key reasons for this are that Chinese firms are generally undervalued in the US, because their business models are almost entirely focused on the domestic market, meaning that international investors have difficulty understanding what they actually do, and because Chinese firms have a reputation of having a lower quality of corporate governance than the West. Secondly, valuations in China for these firms remain higher than in the US.
As an example, when Qihoo announced its $10 billion privatisation bid, it was estimated that its value in China would be $60 billion. So for Chinese firms, de-listing in the US, having the management buy out all the stock and the company then relisting in China, makes a lot of sense.
However, doubts rose over this wave of privatisation bids when Chinese domestic equity markets fell over 30% in the space of a few weeks. It was assumed that many of these bids were based on the ability to raise capital in the equity markets, but after the market rout, and the subsequent government regulations imposed on margin trading, it is likely that we will see several of these deal collapse.
Many of these deals were almost certainly based on the assumption that money could be raised in China to fund the management buyouts, but as margin lending fell, doubts were raised over the ability of the buyout teams to raise the required capital to complete the deals.
Aside from the larger Chinese firms, such as Alibaba and Baidu, most Chinese firms meet the criteria for privatisation and relisting in China. In fact, the majority of Chinese firms which haven’t announced privatisation bids are the ecommerce firms, such as VIPshop, Jumei and JD.com.
This perhaps speaks volumes of their international expansion plans, and the recognition that they would get from a US listing, as opposed to the majority of Chinese firms who focus entirely on the domestic market, and have no short-term plans to expand outside of China.
Although most of the deals were announced in May and June, management teams have given very little further commentary, so investors have been left in some doubt as to whether or not the deals will materialise.
Despite most privatisation bids being announced two months ago, only Wuxi Pharmatech, Momo and 21Vianet are trading higher than before the bid was announced. But this shouldn't be seen as particularly bearish. Investors should consider that given the equity crash in mainland China over the past month and the effect on US-listed Chinese firms, the current price of these firms is realistic.
In addition, as we are coming into earnings season, firms will have to give more commentary on these bids. Qihoo has already committed to its privatisation plan, and I expect that other firms will do so too in the coming weeks.
In addition, Jack Ma has often stated that Alibaba’s financial subsidiary Ant Financial, which owns mobile payment leader Alipay and a stake in the internet bank MyBank, will list in Shanghai, with the most likely time being 2016.
Therefore there is a marked shift away from Chinese firms listing in the US towards making plans to list domestically. Whether or not the current privatisation bids are completed remains to be seen, but if not, I would expect a further privatisation bid in the near future.
An unknown variable is the role of the government. We have seen over the past 12 months how China’s financial markets have developed with the intent of making Shanghai a major global financial centre and major Chinese firms returning to mainland indices from abroad would boost this goal.
Government intervention in equity markets over the past few weeks has seen a stop to the equity crash, and the markets have begun to rise again. I have previously argued that Beijing would do whatever it takes to prop up equity markets, because it is essential to avoid the mass scale social unrest that falling equities would induce, even if this means loss of credibility.
So after all of the measures that the government has introduced over the past few weeks, investors should consider how these would be derailed if the vast majority of US-listed Chinese firms decided to scrap their privatisation bids.
The government went back on its previous aggressive stance on leveraged trading, and unsurprisingly margin-trading volumes are rising, so this should help to put an end to falling equity prices over the coming months. It should also help investors to raise more capital, which has likely funded the privatisation bids.
If several smaller firms saw their privatisation bids collapse, it wouldn’t make much of a dent in Beijing’s plans, but if major tech firm Qihoo saw its $10 billion deal collapse, that would cast major doubts over China’s financial market reforms.
The government has shown time again that it will reform financial markets through intervention, and I wouldn’t be surprised if deals such as Qihoo’s were pushed over the line with a little help from the hand of the government.
-- Edited by Adam Courtenay
Neil Flynn is a China watcher based in Shanghai. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform