"Go East, Young Firm": Chinese Companies Drop New York Listings, Return Home

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China’s equity market bubble has become the stuff of legend recently, as millions of newly-minted day traders, record margin debt, liberalized cross-border flows, and the inclusion of China A shares in two transitional EM FTSE Russell benchmark indices have created a veritable frenzy on the SHCOMP and, more spectacularly, on the Shenzhen exchange.

Valuations have soared, as has turnover and the bubble chorus is growing appreciably louder by the day. The following excerpt from a recent BNP note captures the situation nicely.

Momentum buying reinforced by market-capitalisation benchmark weightings could further inflate the bubble. In particular, imminent decisions on the inclusion of A-shares in global equity indices might see strong institutional buying buttress the retail mania for a time. Still, the exponential trends in turnover, margin debt and increasingly valuations imply that a climax is now unlikely to be too far away. The Shenzhen Composite’s P/E ratio is now over 66x (with a median P/E of 108x), compared with the 75.8x P/E at the 2008 bubble peak. 

Of course not everyone thinks the historic run is likely to end anytime soon and indeed, the momentum serves as a siren song to many Chinese companies which have listed on the NYSE. Reuters has more:

Chinese tech firms have fallen out of love with America, and it shows - a growing number of them are looking to drop their listings in New York and head back home.

Many Chinese tech executives are betting on higher share valuations in China where stock markets have recently caught fire. They also hope to evade any legal mess when Beijing formally outlaws foreign shareholder control of firms in protected tech sectors.

The numbers are hard to resist. China's tech-driven ChiNext composite index has gained nearly 180 percent this year, eclipsing the 30 percent rise in the Nasdaq OMX China Technology Index that tracks offshore listed mainland firms .

Firms listed on the Nasdaq index get an average share price equal to 11 times their earnings. On ChiNext, they get 133 times. There's a debate over which ratio is more accurate, but Chinese executives blame U.S. ignorance of China.

"American investors don't understand the business model of Chinese gaming companies," said a senior executive of one such firm planning to eject from New York and move back to a Chinese listing, speaking on condition of anonymity.

Perhaps. Or maybe American investors don't understand the valuations. 133X is a lofty multiple even for America's generally clueless BTFDers and indeed, the mainstream financial media is now awash with reports about China's stock bubble.

Whatever the case, China is relaxing restrictions on tech listings in an apparent effort to encourage more startups to repatriate as Shanghai transitions to a more prominent role in the financial world.

Chinese investors' enthusiasm for startup listings is relatively recent, whereas U.S. investors have been rewarding internet startups with high share prices for decades.

But more important was the fact that Chinese regulators wouldn't let such firms list in the first place. The China Securities Regulatory Commission (CSRC) has required any company to be profitable for several years before listing - a rule which ruled out most Chinese internet companies.

"The obstacle to coming back has been removed," said China Renaissance in an email to Reuters. 

Companies have also devised workarounds for China's profitability restrictions, including convenient (if nonsensical) coporate tie-ups:

Profitability requirements are being eased, and there's also a shortcut: a merger with a Chinese company with a listed shell.

Chinese display advertising giant Focus Media, which bailed out of New York in 2013, said this week it will relist in China via a $7 billion reverse merger with rubber manufacturer Jiangsu Hongda in what analysts say is a model for returnees to follow.

Finally, China may look to close a legal loophole that allows companies in restricted sectors to take in money from foreign investors, a move which could further discourage tech companies from pursuing US listings:

Chinese law bans foreign investment in domestic internet firms. Investors get around the restrictions by buying into variable interest entities (VIEs) set up by the internet companies, including Alibaba. U.S. courts recognise that as equivalent to ownership of the companies.

But now Chinese regulators are revising the foreign investment law. A draft version of the document published by China's cabinet explicitly forbids "effective control" by foreigners of a Chinese company in a prohibited sector.

For Wall Street this means no more hundred million dollar paydays from underwriting highly anticipated Chinese offerings.
For American exchanges, it means that as long as China's self-feeding equity mania persists, US listings make little economic sense. Especially if China makes a concerted effort to bring more companies home.