Weblog with daily updates of the news on a frugal, fair and beautiful China, from the perspective of internet entrepreneur, new media advisor and president of the China Speakers Bureau Fons Tuinstra
Two hundred Chinese companies listed in the US thought they would get a pass when the PCAOB accepted late last year the auditing process for those companies. But financial analyst Winston Ma warns there are still significant uncertainties for those firms, as the SEC still indicates on its website those companies are still in danger of being delisted, he tells CNBC.
After two decades of negotiations, the end game of the struggle between the US and China on listed companies at the NYSE and Nasdaq seems to head into a delisting of 200 listed Chinese firms. Accounting expert Paul Gillis looks back at twenty years of tug wars at Market Place. Moving home, like to the Hong Kong Exchange, might not solve the need for capital, according to Gillis. “The Hong Kong exchange has arguably less liquidity than the U.S. exchanges,” Gillis said. “The investors may find it a little more difficult to get good prices when they’re selling stock.”
Market Place:
Allegations of fraud against U.S.-listed Chinese firms stretch back to the 2000s, when private firms from China began listing on U.S. stock exchanges, according to Paul Gillis, an accounting professor at Peking University’s Guanghua’s School of Management in Beijing.
“Some of them were just outright frauds, and the short sellers attacked these companies in the mid-2000s and had great success at bringing them down,” Gillis said. “That got the attention of U.S. regulators who wanted to try to protect investors by stopping that fraud.”
It has been difficult because China’s government has blocked these efforts…
Under the 2002 Sarbanes-Oxley Act, the Public Company Accounting Oversight Board was created to set audit rules for companies listed on U.S. stock exchanges. The PCAOB also has the power to inspect and enforce the rules. It does not interact with listed companies directly, but instead the PCAOB oversees the auditors.
“When [auditors] do an audit, [they] prepare a set of working papers that document what work they have done to reach the conclusion that the financial statements are correct,” Gillis said.
The PCAOB wants full access to the working papers, but China’s government says this could threaten its national security…
The U.S. worries that China’s definition of state secrets can be broad.
“The PCAOB was able to negotiate the ability to do inspections in every country, except for China,” Gillis said. “China’s also one of the few countries that uses the U.S. capital markets as extensively as it does.”
Negotiations have been on and off for the past 20 years…
“There has been a lot of people who seem to think that these PCAOB inspections are going to be some kind of magic bullet that is going to make fraud in Chinese companies go away,” accounting professor Gillis said. “I don’t believe that is true.”
Chinese firms in need of capital can turn to other stock exchanges, but they are not as appealing. Mainland China’s markets are underdeveloped. Hong Kong’s stock exchange might be the next best alternative to the United States. A few firms are moving in that direction already, but not all U.S.-listed Chinese companies are eligible to list in Hong Kong. American investors can buy stocks of Chinese firms in Hong Kong, though that prospect may not be very attractive.
“The Hong Kong exchange has arguably less liquidity than the U.S. exchanges,” Gillis said. “The investors may find it a little more difficult to get good prices when they’re selling stock.”
Financial analyst Winston Ma discusses the progress of the plan to delist Chinese companies from US stock markets on CNBC. It’s mostly China that has to comply with the US demands for transparency, he says about this work in progress.
Until a few weeks ago, listing at US stock markets was a favorite way to raise capital for fast-growing Chinese companies. That venue is closed now, and VC veteran William Bao Bean sees still bears on the road for on-shore listing’s at China’s stock markets, he tells the South China Morning Post.
The South China Morning Post:
“For years, the biggest exit path for venture-back companies has been the US,” said William Bao Bean, general partner of New Jersey-based venture capital firm SOSV. “But now that has been closed off.”
Compared to going public overseas, Bean said listing in mainland China poses many more challenges for investors because of the country’s strict regulations in both the tech and capital markets.
“When it comes to an onshore listing, the timing is always uncertain [because] it’s hard to see when one can exit. In terms of both liquidity and the experience required, it is not as easy an exit as if it were in the US,” he added.
China has been banning US regulators at the PCAOB from getting access to information of Chinese companies at US stock markets, as they should do according to US regulations to protect its state secrets. But things are changing, notes auditing expert Paul Gillesat his weblog Chinaaccountingblog. "I suspect that Yi’s comments are a signal that China will back down on this issue, allowing joint inspections with adequate controls to protect state secrets," writes Gillis.
Paul Gillis:
Paul Gillis
Caixin has reported($$) some amazing comments from CSRC chairman Yi Huiman. Yi reportedly said that: “As long as the U.S. side is truly willing to solve the problem, we can definitely find a way for China and the U.S to cooperate on audit regulation” HT to Donald Clarke for tipping me off on this.
Yi further added: Chinese law stipulates that exchanging information, such as providing audit working papers for overseas regulators, should be conducted through regulatory cooperation and comply with security and confidentiality regulations. Carrying out joint inspections is a common practice of international cooperation on this issue.
I doubt Yi is unaware of the fact that China has blocked inspections since the passage of Sarbanes Oxley in the early 2000s. The U.S. has certainly shown its willingness to solve the problem, even agreeing to a joint trial inspection that was called off when Chinese regulators would not allow the PCAOB to see documents or ask questions.
Yi is correct that joint inspections are the common practice of international cooperation. I believe this is the first time Chinese authorities have sanctioned that approach. Formerly they argued for regulator equivalency, where US regulators would rely on Chinese regulators to examine auditors. The PCAOB has long rejected that approach, although it was adopted by the EU.
I suspect that Yi’s comments are a signal that China will back down on this issue, allowing joint inspections with adequate controls to protect state secrets.
Chinese listings at US stock markets got recently under fire. Former US assistant trade representative Harry Broadman looks with some amazement at this market at the International Finance Law Review (IFLR). "After decades of working in China intensively on financial accounting, there is not a single state-owned enterprise I've worked on that I can think of that abided by international accounting standards," Broadman says.
The IFLR:
The catalyst for the move is likely Luckin Coffee, the fast-growing Chinese coffee chain that created a network of fake employees and customers that enabled it to grossly fabricate its revenues. Only eight months after going public – on Nasdaq's exchange – the company's valuation had doubled to $12 billion. News of the doctored numbers caused stock to fall by as much as 75% overnight.
"
After decades of working in China intensively on financial accounting, there is not a single state-owned enterprise I've worked on that I can think of that abided by international accounting standards," said Harry Broadman, partner and managing director of the emerging markets practice at Berkeley Research Group. "Some of these firms are now listed on the US markets. I've not examined those firms' recent financial accounts, but even if we were given their upstream numbers, the source and integrity of those numbers has always been, in my mind, very dubious."
"I am surprised that it has taken this long, just in terms of the sheer due diligence and regulatory integrity check. I wasn't aware of exactly how many of those Chinese firms were listed on US markets, but I'm actually quite shocked there were that many," he added, "That's not a comment about the Chinese, but about US regulators."
"Anybody who understands how state owned Chinese firms keep accounts, even some of the more privately oriented of them, knows they are just not completely grounded in international accounting standards, like a US firm or a British firm," he said. "Anyone who thinks that is quite myopic."
The tech giant Alibaba listing on the Hong Kong stock market is already a sign things are changing for the US markets, and the ongoing trade war will stop many Chinese firms to list in the US, as they did in the past, especially when a bill by US Senator Marco Rubio is adopted or not, says Beida accounting professor Paul Gillis in Forbes.
Forbes:
The U.S. environment is getting increasingly hostile for China-related IPOs.
Earlier this month, a bipartisan group of lawmakers, including Republican Senator Marco Rubio and Democratic Senator Bob Menendez, introduced a bill that would require U.S.-listed Chinese firms to comply with increased financial oversight–such as providing access to auditing–or face delisting. The Public Company Accounting Oversight Board (PCAOB) in the U.S. routinely inspects the accounting practices of U.S.-listed firms, but China, citing national security concerns, has barred overseas regulators from examining the companies’ audit and financial records.
Whether the bill would become law probably depends on trade negotiations between the U.S. and China, as it could likely be resolved as part of any deal that comes out of those talks, says Paul Gillis, professor of practice and co-director of the IMBA program at Peking University's Guanghua School of Management. He warns that “there is likely to be no more listings” from China on U.S. markets if the bill is passed because no China-based accounting firm is currently inspected by the PCAOB and Chinese law forbids them from handing financial records over to foreign regulators.
“It [passing the law] would be troublesome for U.S. stock exchanges and investment banks,” he says.
US Senator Marco Rubio is drafting a law, the Equity Act, to kick out 156 Chinese companies from US stock markets, unless they comply with the oversight by the Public Company Oversight Board (PCOB) of their information. Beida accounting professor Paul Gillis believes this act might be passed, and although it is not the hottest issue in the ongoing trade war between China and the US, companies will have three years to move, for example to Hong Kong, he writes in the Chinaaccountingblog.
Paul Gillis:
The proposal effectively says that Chinese companies will be kicked off US exchanges in three years if a breakthrough in PCAOB inspections does not take place. At this stage, I would call it an even bet as to whether China negotiates a settlement. I don’t think this is a critical issue for China, and I think China could craft a deal, but I can’t see what the US would offer in exchange.
I think this legislation has a good chance of passing, and that will start the three-year countdown for negotiations or for the companies to find another listing home. I expect most of them will move their listings to Hong Kong. Mainland exchanges are not ready for most of these companies. There will likely be some regulatory changes required in Hong Kong to make this happen. Most of the companies have weighted voting rights, and Hong Kong now allows for IPOs of unicorns with weighted voting rights, but most of these companies would likely need special accommodation.
If the move to Hong Kong is not seamless, there may be trading opportunities present.
Many mutual funds are not permitted to hold illiquid securities, and it is possible that there will be a period of time while the listings move where the stock cannot be traded. Prices may temporarily suffer until the listing is restored in Hong Kong.
Hong Kong could speed the relocation process by allowing the companies to use SEC documents and US GAAP financial statements for the initial listings. Hong Kong generally requires companies to prepare financial statements under Hong Kong Financial Reporting Standards, which are equivalent to IFRS. The Rubio proposal is a full employment act for accountants and lawyers.
For many outside China the successful IPO on Nasdaq of group purchasing platform Pinduoduo, mildly comparable to the less successful Groupon, came as a surprise. Shanghai-based business analyst Ben Cavender tries to explain the success at Inkstone. It uses the popular Tencent platforms WeChat and QQ.
Inkstone:
Pinduoduo has a mini-game called “Duo Duo Orchard,” in which players plant a tree of their choosing on the app and collect points by logging in daily, making purchases and inviting friends. After collecting a certain number of points, users will receive a box of fresh fruit.
Pinduoduo’s social media features give it “more stickiness” than Groupon, according to Ben Cavender, a senior analyst with the Shanghai-based China Market Research Group.
“It generates a lot more interest and there’s an entertainment value to the shopping process,” Cavender told Inkstone...
China’s online shopping market has long been dominated by two giants, Taobao of Alibaba (which also owns Inkstone) and JD.com.
Pingduoduo had 168 million monthly active users in May, behind Alibaba's 502 million and JD.com’s 273 million, according to data compiled by consulting firm Jiguang.
“I think increasingly what we are going to see is more space for different kinds of models,” Cavender says. “It may take some share away from Taobao and some of the low-end market share away from [Taobao-owned] Tmall and JD.com. But Pinduoduo’s not going to replace them.”
Currently, the majority of Pinduoduo’s users live in cities with populations of fewer than three million people – small cities with users who are more price-sensitive.
In the more affluent cities, Taobao and JD.com still dominate...
“If Alibaba decides that’s a market they want to own, they are going to spend a lot of money, and Tencent has to decide how much they want to support Pinduoduo’s long-term growth,” Cavender says.
Spinoffs are typically business transactions where the total of all entities increase their value by splitting up their existing business. But not so for Chinese companies, listed in the US, argues Beida accounting professor Paul Gillis. Not the shareholders or the company gains, but mostly management, he explains at his weblog.
Paul Gillis:
Spinoffs are situations where a corporation disposes of part of its business by giving shares in the business to shareholders. When they work, the value of the parts is greater than the value of the whole. “Spinoffs” of US listed Chinese companies work differently.
A favorite transaction of US listed Chinese companies is to "spin off" parts of the business in a new entity in an IPO transaction. Shareholders of the parent company are not distributed shares of the company that does an IPO although they may benefit if the value of the underlying shares is recognized in the stock price. There have been a number of these transactions and several in the pipeline.
I have observed, however, that the biggest winners in these transactions appear to be members of management. Management typically ends up with a big chunk of these deals which are structured in a way that does not report as expense the value transferred to them.
Rather than point to a specific transaction, I am going to examine these transactions through a straw man. When I look at specific transactions, I find the public documents obscure what is going on and add bells and whistles that do not alter the essence of the transaction while providing arguments to counter any attacks on the structure. So, the transaction I describe below is fictitious, although I think fairly represents what is going on. I leave it to others to apply this to specific transactions. I apologize, but this simplified example is still complicated as hell.
Guanxi used to be a key word when foreigners came to China to do business, including business women Fredy Bush, the founder of Nasdaq-listed Xinhua Finance, a successful deal in the tough media industry. Wealth editor Wei Gu explains for the WSJ why the now-jailed tycoon could not survive now times have changed.
Foreign firms have a hard time in adjusting to the fast changing times in China, where consumers and government rules become more important than guanxi, the connections with the powerful. In the China Weekly Hangout on January 30, 2013, panelist +Richard Brubaker of Collective Responsibility and +Andrew Hupert, expert on conflict management in China, discussed the changing playing field for foreign companies. Moderation: +Fons Tuinstra of the +China Speakers Bureau. Including references to Apple, Mediamarkt, Foxconn and many others.
China's second largest video sharing firm Tudou launched last week successfully at Nasdaq, and business analyst Shaun Rein discovered they want "buy things". Wrong, he argues in CNBC: Tudou should focus on its sustainability and become profitable.
Shaun Rein:
I expected after the IPO, Tudou’s investors and management would talk about how Tudou would use its war chest to develop profits. Instead David Orfao, a Tudou board member and managing director of venture capital firm General Catalyst, focused on what Tudou would buyin an interview with the Wall Street Journal. He said Tudou “ need(s) to continue to buy quality video content. They need to scale their infrastructure. Delivering these videos in a quality manner with minimal delay is key."
The founder of Tudou, Gary Wang, told the blogger Gang Lu after the IPOthat the proceeds raised would be used mainly for content, bandwidth and platform upgrades.
Orfao and Wang barely touched upon how Tudou would actually start to generate more revenues and profits, but on how they would buy stuff. That is deeply concerning for a company losing tens of millions a year.
If Tudou can figure out a way to develop a sustainable business model and lower bandwidth and other costs investors might want to take a look especially if the price drops further as they might become a takeover target for well capitalized firms like Baidu.
"It makes sense for Xunlei to postpone their IPO because it is doubtful they would have received a warm welcome," said Shaun Rein, founder and managing director of the China Market Research Group, a strategic market intelligence firm in Shanghai.
Rein added it is "a terrible time" for Chinese companies to list on the US stock market after a number of accounting scandals have damaged the credibility of US-listed Chinese companies.
Xunlei, which booked $47 million in sales over the last 12 months, planned to list on the Nasdaq under the symbol XNET and has JPMorgan and Deutsche Securities as the lead underwriters on the deal.
Xunlei hoped to raise $114 million by offering 7.6 million American Depositary Shares (ADS) in a price range between $14 and $16...
Short sellers such as Muddy Waters Research have accused Chinese companies such as US-listed Sino-Forest, the Hong Kong-based operator of tree plantations, and Spreadtrum, the Shanghai-based chip designer, of fraud, although both companies' shares have rebounded from their lows in recent weeks.
Last week, rating agency Moody's Investor Service raised warnings about accounting and corporate governance risks at more than 40 China-based companies. "Sentiment is against Chinese Internet stocks right now. Aside from fears about reverse mergers, there are fears of volatility," Rein said.
Shares of online bookseller E-Commerce China Dangdang, which surged 87 per cent on their New York Stock Exchange debut in December and peaked even higher in January, fell below their IPO price for the first time last week.
Renren's shares jumped 29 per cent on their debut a month ago but sank back below their IPO price of $US14 the next week, and were trading at $US7.90 in New York.
And Baidu's shares have fallen 20 per cent from a closing peak seven weeks ago, wiping out about $US10.7 billion in market value .
In roughly the same period, the Nasdaq Composite index has fallen 7.6 per cent from a closing peak in late April and China's benchmark stock index has fallen 11.5 per cent from a closing peak that month.
"There are fewer and fewer and fewer reasons to expect any increase in the stock prices - there are fewer positive catalysts, and investors are looking for reasons to sell," said William Bao Bean, managing director of investment at SingTel Innov8, a venture-capital unit of Singapore Telecommunications.
"I think what you'll see is a gradual deflation. The stocks have to grow into their valuations."
China's one-year old stock exchange ChiNext - comparable with Nasdaq - might not have brought many investors high returns, writes Bloomberg, but has according to Rupert Hoogewerf, composer of the Hurun rich list, increased the wealth and raised the number of billionaires.
The creation of ChiNext helped spark a jump in the number of rich Chinese, said Rupert Hoogewerf, founder of the Hurun Report, which compiles an annual list of China’s wealthiest people.
“This year we’ve found about 400 people with a billion yuan, many of them coming through listings,” Hoogewerf said in an interview in Beijing last month. “We’ve seen ChiNext create a whole lot of new wealth that we didn’t even know existed.”
Local investment banks have benefited too. Fees for ChiNext IPOs average 5.14 percent, according to Bloomberg data, more than double those for first-time sales on the main board in Shanghai. ChiNext offerings have generated 5.17 billion yuan in total fees, the data show.
