October 29, 2018
The quiet transformation of Chinese investing
Mark Webster, Co-head & Managing Director, BDA Shanghai
For a number of years now initial public offerings by Chinese companies have captured public attention. Stock exchanges around the world vie to attract the latest candidates to list on their markets and investors clamor to take part in the next big thing. This situation could be about to change, however, as a quiet transformation takes place across the Chinese investment landscape.
While much is currently being discussed about the impact the ongoing US-China trade war is having on company listings, the forces driving change are actually more complex. Rather, a radically different attitude by companies – specifically their owners – is reshaping things, often behind the scenes. This reflects the greater scrutiny being placed by Chinese regulators on IPO candidates, and is a direct result of the increased proportion of IPO rejections seen so far in 2018.
In 2017, around 78 percent of applicants were approved for IPO, with only 18 percent rejected (the rest being subject to ongoing review). This year has seen approvals fall to 54 percent and rejections rise to 41 percent. That is a rise in rejection rate of over 120 percent. The primary reason for this is the new China Securities Issuance Examination Committee (CSIEC), established in October 2017, which has introduced greater rigor into the IPO review and approval process.
The approval committee is more diverse than its predecessor, made up of former regulators complemented by external financial services professionals. Crucially, each member now has lifelong accountability for committee decisions. That has duly enhanced the depth of review each application receives. The impact of this heightened scrutiny is perhaps best demonstrated by the fact that 148 applicants have voluntarily withdrawn from the process since the CSIEC was formed, compared to just 53 beforehand in 2017. Companies can see the new committee means business, and are excusing themselves if they do not fit the bill.
By far the most common reason for rejection is concern around the firm’s profitability, especially authenticity of financial data disclosed or the strength of its accounting standards. Other reasons center on the sustainability of the firm’s business model and industry growth, as well as issues with related party transactions and other compliance issues. Risks from having an overly-concentrated customer or supplier base have also been increasingly cited as a deal-breaker of late.
Some business owners do then go away and work on these factors, but many lack the time and resources required to effect the required changes to their businesses. Still more owners are seeing firms similar to theirs get rejected or pull out of the process, and decide not to embark on a listing at all. IPOs are no longer the obvious stage in a company’s natural progression they once were.
This is having a long-term impact on the Chinese investment landscape. Succession issues, the main driver for selling businesses, are very much still there with many family-owned firms lacking a next generation willing to take over the reins. Unlike in Japan or Korea, where if one child decides to pursue a different career other siblings typically take their place, the legacy of China’s one child policy means many sole heirs are coming of age with very different business interests and life goals from their parents. As founders age, selling becomes an imperative, but, with the path to IPO now more challenging, alternative routes need to be examined.
Owners are therefore getting more creative about the types of sale they plan for their businesses and this in turn is causing the local investment landscape to evolve. Private-equity (PE) deals, sales to other companies and even sales between PE companies – previously rarely heard of – are all growing in popularity.
Further fuelling this process is the sheer amount of money raised by global funds waiting to be used in China. These funds are themselves responding to the changing environment by altering their investment style. Previously used to taking small stakes in fast growing companies across a range of sectors, they are now much more comfortable taking larger stakes and stepping in to run the business themselves. These new owners have the bandwidth, resources and expertise to make the changes required to ready a firm for a successful IPO.
While the trade war rages and its impact on markets is debated, the quiet transformation of the Chinese investment landscape continues unabated. The lifecycle of a company is becoming more sophisticated with more and more company owners realising that an IPO in the short term may not be the right path to take. Instead, spurred by the greater oversight of the regulator, they are looking for a different way to take their businesses to the next stage of development. With the right new ownership, this ultimately means we will see more successful IPO candidates come to market in the long term, strengthening Chinese businesses’ position in the global economy.
What this means overall is that the Chinese investment scene continues to mature, driven by its own internal processes – regardless of the outcome of the trade wars.