March 20, 2012
For Chinese companies that went public in the U.S. markets prior to 2011, particularly those that became public through an RTO, the ability to raise money in the U.S. capital markets has declined significantly since a number of high profile fraud allegations were made by various short sellers in the past two years. These allegations started a landslide of negative consequences for many Chinese companies listed in the U.S., including but not limited to, delisting of companies’ stock from markets such as Nasdaq and NYSE-AMEX, regulatory investigations and class action law suits. As a result, even if your company has survived without one or more of these negative circumstances, raising new capital from the U.S. markets has become extremely difficult since 2011. These circumstances are even more serious if the company is unable to secure financing from other sources, such as bank loans. Management of many Chinese companies whose stock is publicly traded in the U.S. now feel trapped in that they still have all of the costs of maintaining their public listing in the U.S. but cannot recognize one of the main benefits that led them to choose a public listing in the first instance: the ability to raise capital publicly.
All is not lost, however, as there are still numerous options available to such companies, depending on their respective goals and needs. Before a company starts to examine its financing options, its management and board of directors should first determine what the company’s goals are in both the short and long term. If, for example, management and the board of a company have determined that remaining a public company in the U.S. is not in their long term interest, they may want to consider private equity financing in conjunction with a “going private” strategy. Numerous private equity firms, many of whom are based in Asia, have taken advantage of depressed valuations for Chinese companies in order to finance these companies’ exit from the U.S. public markets. Sometimes, these companies will remain private after leaving the U.S. market and other times these companies will seek to “re-IPO” on another exchange such as Hong Kong, Shanghai or Singapore. Some companies, however, may decide that either they do not wish to exit the U.S. capital markets or even if they do wish to “go private” that such a strategy is not in the long term interests of the company. For these latter companies, private equity investment will probably not be a viable option.
Another option that Chinese companies may want to consider is strategic investment. The Chinese market is still very difficult for foreign companies to understand and penetrate. As a result, there are many non-Chinese companies that are willing to enter into a strategic relationship with a Chinese competitor or partner. Such opportunities may include the licensing of a foreign product for sale in the Chinese market or a distribution arrangement whereby the Chinese company assists in the distribution and sale of the strategic partner’s products in the Chinese market. These types of arrangements, although not always easy to identify, can lead to a win-win situation for both companies, giving the strategic partner an entrée to the Chinese market and providing the Chinese company with additional capital to operate its business. Another benefit to the Chinese partner is also the additional credibility outside of China that having a U.S. or other foreign strategic investor often provides. Unfortunately, strategic relationships are often difficult to identify and can take a long time to develop to completion.
As a result, for companies who still wish to remain public in the U.S., or who see no other choice at present, but who do not have the ability to attract strategic financing, this leaves more traditional financing options. Although recently U.S. investors have been skeptical of Chinese companies, this trend may be starting run its course. Investors are beginning to recognize that despite the negative press of the last two years, there are some very good Chinese companies that are still publicly traded in the U.S. Even long time short sellers, such as Muddy Waters, have now announced that they are looking for good “long” investments. As a result, the key issue for management of a Chinese company whose stock trades publicly in the U.S. and who wishes to remain public and attract new investors, is how to distinguish your company as a good company that is worth investing in. In order to do this it is important to first briefly examine some of the main concerns that investors and regulators have recently had with Chinese companies. These concerns usually address the veracity of the company’s financial statements and, in particular, confirmation of cash balances, revenue recognition, validation of customers and disclosure of related party transactions.
Since most of these concerns address the sufficiency of a company’s financial reporting and disclosure, there are a number of pro-active steps that management of a Chinese company can take in order to give potential investors greater comfort, and, as a result, make your company more easily financeable. A good place to start is with the board of directors of the company. Having one or more independent investors with experience in either international finance, U.S. GAAP reporting and/or U.S. law will show investors that the company is serious about meeting the standards required for U.S. public companies. Similarly, utilizing an outside audit firm that has an international presence and significant operations in both the U.S. and China will give investors greater confidence in the accuracy of the company’s financial statements. This does not mean that a company has to hire a “Big Four” accounting firm but there are many reputable mid-size firms with significant China practices and experience in U.S. GAAP. Additionally, the company should invest in an appropriate investor relations strategy. This will usually involve hiring a credible and experienced investor relations firm to tell the company’s story to the investment community. Companies should look for investor relations firms that have other Chinese clients and a good reputation in the industry. For certain companies it may also be beneficial to have an in-house spokesperson that is fluent in English in order to communicate with potential and existing investors. This will send a message to investors that the company is serious about effective communication with its non-Chinese investors.
All of the above steps will help to distinguish the best Chinese companies from the rest. And, although some of these steps will require additional investment from the Company, if they result in additional investment, they will be well worth it. Finally, having more effective communication with existing and potential investors will alert company management to the perceived strengths and weaknesses of the company so that they can be pro-active in formulating a strategy for success.
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