As China’s new Nasdaq-style board speeds to welcome its first IPOs, here’s a look at what’s changed for Chinese tech firms listing in the mainland, and if it could be pivotal in the emerging tech cold war
As the US-China trade war escalates into a tech cold war, China is launching its new Nasdaq-style board as early as this month, seeking to wean its best tech companies off US capital markets and funding.
This Wednesday, the Shanghai Stock Exchange will announce the application results of the first three companies that filed to list on the new tech board, namely Shenzhen ChipScreen Biosciences, Anji Microelectronics (Shanghai) and Suzhou Tztek Technology.
Preparatory work for the new board has been fast-tracked since President Xi Jinping announced a plan to launch a Nasdaq-style board in November 2018. Since the early 2000s, most of China's high-profile tech companies have gone public outside of the mainland. Baidu and Alibaba shares are listed in New York and Tencent in Hong Kong; the newer generation of Chinese tech giants such as Xiaomi and NIO have also followed suit.
With the new Shanghai tech board, China aims to keep its tech companies and the financial gains from their IPOs within the country. In 2018, Chinese companies raised US$64.2 billion through IPOs, nearly one-third of the global total. But only US$19.7 billion of that came from the Shanghai and Shenzhen stock exchanges, while listings in Hong Kong and New York made up nearly 70% of the funds raised.
The new board is also seen as a necessary countermove in the ongoing trade conflict between China and the US. According to Ying Wenlu, Chairman and Founder of Addor Capital, one of China’s top VCs, the tech board is a forced choice – but a right and necessary one – by China in response to the trade war.
Securing its technological – and financial – independence from the US is more pressing for China than ever. Tensions between the two nations have heightened since talks froze in early May, with both sides proceeding to raise tariffs on US$310 billion worth of imports combined. On June 2, top Chinese officials speaking at a global forum in Singapore blamed the US for “resorting to intimidation and coercion,” saying “if they want a fight, we will fight to the end.”
Current options unattractive
The investment bank China International Capital Corporation (CICC) has predicted that about 150 firms will be listed in 2019, raising a total of US$7.46–14.92 billion.
The new tech board will house startups with high growth potential and core technologies in the sectors of next-generation internet technology, advanced equipment, new materials, new energy, environmental protection and biomedicine. Of the 100 firms currently being vetted for listing as of May 6, 23 are from the computer, communications and electronics manufacturing industries.
“The new board aims to better serve innovation-oriented enterprises and will act as a prelude to broader capital market reforms in the country,” said Yi Huiman, chairman of regulatory body China Securities Regulatory Commission (CSRC).
The Shanghai tech board is not China's first attempt to foster tech innovation and boost funding opportunities for such companies. The ChiNext board on the Shenzhen Stock Exchange and Beijing’s National Equities Exchange and Quotations (NEEQ), also known as the New Third Board, were launched in 2009 and 2013, respectively, for tech listings.
But listing requirements for both boards have been onerous, and incompatible especially with the nature of successful tech startups that could be worth billions of dollars but remain loss-making. ChiNext requires companies to post two consecutive years of profit before they can list. No surprise then that last year, two of China’s biggest and most feted startups, Meituan-Dianping and NIO, pursued overseas IPOs, given their respective losses of RMB 8.52 billion and RMB 9.6 billion in 2018.
Although the OTC NEEQ has a lower profitability threshold for listing aspirants, it demands that retail investors trading in its market have at least RMB 5 million in securities assets and two years of experience in stock investing. Home to 10,691 companies, NEEQ reports a low daily trading volume of RMB 200-300 million, compared with RMB 100 billion on ChiNext, which has 753 listed companies.
Such restrictions also mean that Chinese investors have been sidelined from betting on and enjoying the financial gains of successful homegrown tech companies that list abroad.
"We should really lower the thresholds," said Liu Qingfeng, Founder and Chairman of iFlytek, a voice recognition tech company that listed on the Shenzhen Stock Exchange in 2008. "A promising startup has the chance to go public in the US, but in China only those that have already made a fortune can get listed. How can we take over the lead in emerging tech sectors such as IoT and AI this way?"
Two to seven years’ wait
Liu's comments couldn’t be more spot-on.
China is now promising a more relaxed listing criteria with the new board. An applicant company valued at around RMB 3 billion, for example, would need to have generated just a minimum RMB 100 million in operating revenue in its latest financial year, making it possible for loss-making startups to get listed.
“It’s good news for us,” said Chen Qiyan, founder and CEO of Shanghai-based cloud computing startup DaoCloud. The firm, which hasn’t yet broken even, was aiming to list on ChiNext in 2021; now it’s considering an earlier IPO.
Google-backed AI unicorn Mobvoi is reportedly planning an IPO on the new tech board, which “opens the door to companies with high R&D expenditures and unclear business models,” said founder and CEO Li Zhifei. Mobvoi remains in the red, and R&D costs eat up 70% of its revenue, estimated at RMB 1 billion in 2018. The company has declined to comment on the listing rumor.
For applicants to the new tech board, its registration-based system promises a smoother path to IPO. According to the regulator CSRC, application reviews by the Shanghai Stock Exchange won’t take longer than three months. Upon receiving the review documents from the Shanghai bourse, CSRC will decide whether to allow the applicants to file within 20 working days. The whole process will take just six to nine months in total.
In contrast, under the current approval-based IPO system, companies applying to list on Chinese securities markets usually wait two to seven years before they get vetted by CSRC. During the review period, the companies also face restrictions in share transfer, capital increase, share expansion, M&As and restructuring, which risk capping their growth opportunities. In 2018, there were 105 successful IPOs in mainland China. At the same time, 264 applicants were still waiting for regulatory review.
Dual-class share, VIE structures now OK
Departing from current listing conditions, the new tech board will allow listing companies to use a dual-class share structure, which is popular among startups. Dual-class share structures allow founders and early investors to retain extra voting rights and thus maintain control over the direction of their companies while continuing to receive outside investment.
Facebook Founder and CEO Mark Zuckerberg holds about a 14% stake in his company but controls around 60% of its voting rights, for example. JD.com, Baidu, Meituan-Dianping and Xiaomi also use a dual-class share structure.
According to the rules of the new tech board, preferred shares can carry a maximum of 10 times the voting power of ordinary shares. Shanghai-based cloud services provider UCloud Information Technology's prospectus indicates a voting differential of 5:1 between Class A shares and Class B shares. This means the company’s three co-founders, who collectively hold about 27% of UCloud’s shares, control 65% of voting rights.
In another major shift, Chinese companies with a variable interest entity (VIE) structure can now also get listed on the new tech board by issuing Chinese Depositary Receipts (CDRs). For those already listed overseas, delisting from foreign bourses is no longer a prerequisite.
To date, to circumvent China’s restrictions on foreign investment in sectors such as telecommunications, internet technology and e-commerce, many Chinese startups adopt the VIE structure that enables foreign entities investing in US dollars to acquire key stakes in their companies. Baidu, Tencent, Alibaba and Sina have all used VIE structures to raise funds from investors such as Qualcomm Ventures, Temasek and Softbank, and list overseas. SenseTime, currently the world’s most valuable AI startup, also uses the structure.
Because stocks on the Shanghai and Shenzhen exchanges are valued in renminbi, startups that want to be listed on either exchange are required to dismantle any such structure, which is time-consuming and costly.
There has been confusion over the VIE structure-related requirements though.
Applicant companies with the VIE structure are required to disclose extra information, such as details about the structures and CDRs. E-scooter maker Ninebot is the first and only company whose application to list on the new tech board has been accepted by the Shanghai Stock Exchange for review so far. But one month later, after receiving documents from the bourse demanding further auditing materials, the company applied to have the review suspended.
In any case, the new tech board's acceptance of the VIE structure may still not be enough to convince the foreign investors backing Chinese startups. The hassles of foreign exchange settlement and capital controls restricting the movement of money in and out of China remain barriers to choosing a mainland listing.
Optimism or uncertainty?
Since the Shanghai Stock Exchange began accepting IPO applications for the new tech board in March, as of May 6, 69 of the 100 applicants intend to raise less than RMB 1 billion through their IPOs. The biggest will be China Railway Signal & Communication Corporation Limited, a rail signal and communication tech provider that plans to raise RMB 10.5 billion.
But the public has been notably dismayed by the lack of big names among those seeking to list. TikTok and Musical.y owner ByteDance, SenseTime and drone maker DJI have denied rumors that they are looking to list on the new board.
Although the rules for listing on the new tech board have been relaxed, the regulator CRSC has imposed more stringent rules for staying listed, to ensure that only the strongest companies remain in the market. This means that listed companies failing to meet four specific benchmarks – trading volume, stock price, number of shareholders and market value – will be delisted.
For example, a listed company with a market value of less than RMB 300 million for 20 consecutive trading days will be delisted directly without trading suspension. Companies whose main business is no longer their primary source of revenue, or can no longer sustain their operations, will also be kicked out.
Niuniu Finance Research Center has predicted more than 7% of companies will be delisted by the new tech board every year, compared with fewer than 0.075% in the Shanghai and Shenzhen bourses.
With all the risks and uncertainties, it might be some time before startups and investors gain confidence in the new tech board. During the last two decades, Nasdaq has delisted over 15,000 companies, with left-for-dead stocks accounting for 70% of listed companies. But the exchange has also bred the world’s largest tech companies, including Apple, Amazon, Microsoft and Google.
With most Chinese internet companies having gone overseas for their IPOs in the past 20 years, China’s stock markets and investors have largely missed out on the financial returns of the country’s internet boom. The launch of this new Nasdaq-style tech board has given hope to some industry observers.
Wang Chaoyong, founding partner and CEO of ChinaEquity Group, for one, expects the new board to grow into a cradle for the next “BATs,” now that the best of China’s tech firms can list more easily in the mainland, even at early stages, and the Chinese investing public can participate in their success.
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