China’s IPO market

In 2016, growth in the global IPO market declined significantly from its pace in 2015. While the number of IPOs dropped in Asia as well, the decrease in growth in the Asian market was not nearly as severe. According to figures from KPMG, the Shanghai Stock Exchange (SSE) was the second largest IPO market in terms of funds raised in 2016, behind the Hong Kong Stock Exchange but ahead of the New York Stock Exchange (NYSE).

   While the decline of activity in the U.S. IPO market can be attributed to a string of disappointing IPOs and a lack of superstars to reverse the trend, the Chinese IPO market suffers from a traffic jam of companies looking to go public. After filing for an IPO in China, a company has to wait an estimated 30 months before being able to raise public capital—an exponentially longer timeframe than the three months needed in the United States. As a result, there are over 600 companies still waiting in line, according to figures from December 2016 gathered by the China Securities Regulatory Committee.

   The sluggish pace of the IPO process in China is dependent on a multitude of factors.

   First, China’s stock exchanges are extremely volatile. After a crash in July of 2015, China halted all pending IPOs until November later that year. IPO activity has been sluggish ever since, as regulators seek to stabilize the market and fear that a flood of new listings could cause crashes similar to the one seen in 2015.

   Second, government regulation is stringent and companies looking to go public must undergo a rigorous vetting process. One particularly limiting requirement is that companies filing for an IPO must demonstrate three consecutive years of profits. Companies are also not allowed to change their ownership structure once they apply, preventing companies from participating in mergers or acquisitions that may bolster their business.

   One result of the time-consuming vetting process is that any companies that do manage to go public have seen highly successful IPOs. The limited number of IPOs heightens early market demand, and as a result, only two percent of listings on the Shanghai and Shenzhen exchanges fell on the first day of trading from 2009 to 2015. Conversely, the uncertainty surrounding IPOs has damaged corporate management structures, making it more difficult for publicly listed companies to retain executives since their influence companies is reduced.

   The rule has pushed some companies to pursue backdoor listings by merging with a company that is already public. One high-profile company which elected to take this route was SF Holdings, the holding company that operates SF Express, one of China’s largest courier companies. By  purchasing Maanshan Dingtai Rare Earth & New Material Co, a manufacturer of steel wire, and using it as a shell company to inject their assets into, SF Holdings was ultimately able to publicly list its own company. The reverse-merger has been extremely successful, as SF Holdings now has a market cap of $33 billion, the largest market cap of any company listed on the Shenzhen Stock Exchange.

   In September 2016, China introduced a new fast-track policy that was meant to reduce the congestion of IPO traffic. The new policy stipulates that companies from poor areas of the country can have their application approved in a few months rather than years. Some companies have even relocated their headquarters in attempts to go public faster under the new rule. Tibet Aim Pharma, a Lhasa-based pharmaceutical company, is legally registered in Lhasa but still has its production center based in Sichuan. Their IPO was approved months after they filed and their shares are valued at over $30 (at the time of publication) since opening at $7.27 in December of 2016. However, it still remains unclear what exactly a company must do to be officially reclassified as being from a poor region.

   The fast-track policy has been ineffective. For starters, very few companies—perhaps as few as four according to the Securities Times, a subsidiary to the state-operated People’s Daily—in line for IPO approval can utilize the rule. Hundreds of IPO applicants are clustered in the richer provinces on the coast, while the majority of poorer, inland provinces have less than five applicants. Additionally, the method by which a province was considered poor and included in the rule was based on numbers that have barely been updated since their initial collection in the 1980’s. This process left out counties from the Gansu province, which ranks as one of China’s poorest. Unsurprisingly, the new fast-track has done little to alleviate the IPO bottleneck.

   The choice of counties suggests that the main focus of the Securities Regulatory Committee may have been to redistribute wealth, rather than to unburden the overloaded queue of companies waiting to IPO. Yet, the policy also fails in that regard if so few companies will benefit from the rule. One company that goes public and supplies the local government with tax payments, while a step in the right direction, cannot change the economic status of an entire county. If companies cannot sustain themselves in poorer markets, ultimately they may need to relocate back to larger ones, further widening the wealth gap regulators are trying to close.

   Looking forward, the glut of companies in line will likely remain for years to come. There are over 600 currently waiting, but nearly 700 more in the wings awaiting provincial approval before they also join the stagnant line. Regulators have also looked to prune the waiting list, sifting through companies in line and removing those that do not meet their standards.

   China’s superstars, however, are not affected by the status of the Chinese IPO market. Instead, they look to list on foreign stock exchanges, with tech giants Alibaba listing on the NYSE, Baidu on the NASDAQ, and Tencent on the HKSE. Even unlisted state-owned enterprises look to foreign stock exchanges to raise capital, with Postal Savings Bank of China Co. going public on the HKSE and raising $7.4 billion in the largest IPO of 2016.

   At the outset of 2017, the global IPO market is preparing to bounce back from an uninspiring 2016 and the Chinese market looks to follow suit.

   An encouraging sign at the tail-end of 2016 was the Twilio IPO. Twilio, a tech company, was able to surpass its private sector valuation, unlike the majority of tech companies that went public last year. Its shares were up 90 percent on the third day of trading, and they are up over 100 percent from their initial offering price of fifteen dollars per share. Two of the most anticipated IPOs of the year are Ant Financial, an affiliate of Alibaba, and Snap, the parent company of the messaging app Snapchat. Ant Financial was valued at $60 billion in its last round of fundraising and could look to raise up to $25 billion at a $100 million valuation. Meanwhile, Snap is looking to raise over $3 billion at a valuation over $20 billion.

   China is also currently deliberating on a new fast-track policy that would grant first priority to domestic tech giants looking to list. One of the obvious candidates is Ant Financial. If Ant Financial were to list on a Chinese exchange, such as the SSE or SZSE, this would represent a huge boon for the Chinese IPO market as a whole and could pave the road for future high-profile IPOs. It would also greatly accelerate China’s goal of establishing the global reputation its stock exchanges.

   The Chinese IPO market looks to maintain its strong global position in terms of funds raised and companies looking to list. The SSE surpassed the NYSE last year in funds raised and it will only continue to distance itself further as the market and country both continue to mature.

William Min is a junior at Yale College. Contact him at william.min@yale.edu.

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