Attracted by the high valuations in the A-share market earlier in the year, a record number of Chinese companies have announced plans to delist from the U.S. and are setting their sights on opportunities back home in China. However, the sheer number of deals would put a strain on China’s financial system even in good times. Whether all of those deals will be completed in the manner originally planned by their proponents remains to be seen.
In this Q&A, Corporate partners Douglas Freeman and Victor Chen discuss what is driving this surge in Chinese companies exiting the U.S. market, as well as potential challenges these companies may encounter in going private.
In recent months, a number of Chinese companies announced plans to delist from the U.S. stock market. What is the rationale behind this and what are the benefits in doing so?
Douglas Freeman: There are a number of drivers behind the recent spate of going-private announcements. For one thing, a number of companies have had negative experiences with the U.S. regulatory system and the cost of being a listed U.S. company, including initial and ongoing compliance costs and fees, not to mention the potential risks from lawsuits and regulators, are all relatively high in the U.S.
Victor Chen: I think the lack of liquidity and failure by investors to adequately value Chinese companies in the U.S. are also drivers for these companies. Many of these companies also believe that they would receive a significantly higher valuation listing in China.
What are the next steps for these delisted companies?
Douglas Freeman: I think the next steps for these companies vary, but the reasons they are returning home remain the same: until recently, China’s stock market had been booming, listing rules had loosened, and the financial rewards from being listed in the U.S. remained lackluster in comparison. Given the recent turmoil of the A-share market and last week’s devaluation of the yuan, it is questionable whether all of these deals will be completed in the manner originally planned and whether these delisted companies will consider relisting in China, Hong Kong or another viable listing platform. The value of going-private deals by Chinese companies from the U.S. this year is US$22.4B, according to Dealogic, which is almost double the amount from the previous six years combined.
Victor Chen: Apart from the conventional primary listing, an alternative would be a backdoor listing. The Chinese advertising company Focus Media Holdings, for instance, is one company that completed a going-private deal and is now looking to list in China through a backdoor listing. In this type of listing, a private company merges with a publicly traded one to gain access to the capital markets.
Typically, how are these types of transactions funded and how long do they take to be completed?
Victor Chen: The process of taking a company private from the U.S. usually takes approximately six to eight months. It will not be all smooth sailing, however, for companies that choose to leave the U.S. capital markets. Many of the deals have yet to line up financing and could face scrutiny from independent special committees formed to evaluate the fairness of management buyouts to minority investors.
Douglas Freeman: The funding is comprised of a number of components. For most deals, there is a group of shareholders who form the initial consortium. Often, this group owns a large block of the shares and may bring in new money in the form of other investors such as private equity sponsors, institutional investors or bank funding. Since most of these deals are focused on relisting again in China, the buyer group will not only need to restructure the former U.S. listed offshore holding company into a domestic Chinese entity, but also find financing sources that are capable of participating in such a regulated environment. In light of regulatory restrictions on foreign investment in China’s domestic market, much of the potential financing for going-private transactions is being sought from domestic sources in China, such as domestic RMB funds or Chinese banks.
What are the difficulties and challenges in going private?
Douglas Freeman: Chinese banks have been inundated with financing requests due to the volume of deals that were announced. In fact, it is highly possible that a number of these recently announced deals may have trouble securing funding, especially in light of the recent financial market turmoil in China.
For those that do get funded and want to relist in China, a large challenge lies ahead of them, given the volatility in China’s equity markets, which have seen one of the worst stock market crashes in decades. In early July, Chinese regulators announced a suspension in new listings until the market stabilizes, which could leave many companies in limbo. Then, last week, China meaningfully devalued the yuan, which is having a significant impact globally.
Given the recent volatility in the A-share market, will this going-private trend continue for the remainder of 2015?
Douglas Freeman: I think the trend is set to continue for companies to continue to explore go private opportunities because of the relative differences in the U.S. and China markets.