Video

#SaxoStrats
Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 24 July 2015 at 1:53 GMT

China’s buyouts - home is now where the money is

China Watcher / Shanghai
China
  • 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.

An update on China's privatisation bids
Source: PR Newswire, Yahoo Finance

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.

xxx
 The lure of New York is fading for China firms and many are re-thinking plans. Photo: IStock

Major private firms in China were previously expected to hold their own US IPO, but the government has been keen to keep large Chinese firms in China. Leading O2O firms Dianping and Meituan were expected to compete to be the first Chinese O2O firm to hold a US IPO, but although the much smaller Wowo took that accolade, it is now assumed that both will eventually list in mainland China.

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


4y
Cassy Cassy
This comment has been redacted

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail