Special report

initial public offeringS

China IPOs

the era of transition

After two extraordinary years for initial public

offerings, is China equipped to continue on its
path of diversifying its listing markets and
attracting high levels of capital? James C.
Chapman and Wanli Xu of Nixon Peabody
explain the era of transition in the nation, as it
moves to bolster investor confidence and
encourage domestic listings.
26 ASIAN-COUNSEL

China IPOs the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

he years 2006 and 2007 were extraordinary years

for initial public offerings (IPOs) by Chinese
enterprises. According to Zero2IPO Research
Center, in 2006, a total of 151 Chinese enterprises
launched their IPOs on both domestic and overseas stock
exchanges, with the aggregate amount of capital raised surging
to a record high level of US$62 billion. The year 2006 was
highlighted by the mega-bank IPOs. The IPOs of Industrial
and Commercial Bank of China (ICBC) and the Bank of China
(BOC) together raised US $36 billion on the Hong Kong and
the Shanghai Stock Exchanges. These IPOs, ranked number
one and number five in the world, respectively, in terms of the
largest amount of IPO funds raised in history. The year 2007
exceeded the remarkable performance of 2006 both in the
amount of capital raised and in diversity of listing markets. 242
Chinese enterprises offered US $104.83 billion worth of securities on the Shanghai and Shenzhen Stock Exchanges and on
nine other overseas markets. Moreover, in November 2007,
PetroChinas IPO on the Shanghai Stock Exchange valued the
company at approximately US$1 trillion, making it the most
valuable company in the world at the time.

IPOs remain the most appealing strategy

for Chinese Enterprises
Although management buyouts and mergers and acquisitions
are becoming more and more common in China, most growing Chinese companies still prefer selling shares to the public
through an IPO over other fund raising or exit strategies.
There are many advantages to be obtained in being a
publicly traded company. The trading of a companys securities over a recognised stock market provides the companys
shareholders a market to obtain liquidity for their investment.
Publicly traded securities tend to yield higher share prices
and thus higher valuations for the company. The company
also has greater access to capital through the possibility of
future stock offerings. Being publicly traded gives the company ability to make acquisitions of other companies using
the companys stock as currency and ability to use stock
incentive plans to attract and retain key employees. Being a
public company listed on an overseas market also gives a
Chinese company global visibility which is recognised by
customers and strategic partners. It in turn reinforces the
companys marketplace and financial standings. Finally, publicly traded companies usually have a greater prestige and are
held in higher regard than privately-held companies.
Investors of Chinese enterprises also look to IPOs as

the preferred exit strategy. With the attractive returns on

investments in Chinas emerging markets, many venture
capital and private equity fund investors consider China as
an integral part of their investment strategy. As a result,
China has become the worlds second largest foreign
investment market. Venture capital (VC) and private equity
(PE) firms generally view an IPO as the means of obtaining
the highest returns on their investments.

Going public is like standing in

front of an X-Ray machine forever.
You are completely exposed.
Everything about the business is in
the public domain and in front of
the competition
Anonymous CEO
The advantages of being a publicly traded company and
the investors desire for an exit through the public stock
markets have driven hundreds of Chinese enterprises to go
public on both domestic and overseas stock exchanges.
Chinese enterprises have become key players in the IPO
markets throughout the world.

Determining whether to list on a domestic

or an overseas exchange
With increases in the amount of foreign investment in
China and the number of Chinese companies conducting
IPOs, most major stock exchanges are trying to become
the destination of choices for these companies. In determining where to go public, a Chinese company usually
considers a number of factors including (1) the nature of
the IPO process; (2) the annual costs of being a publicly
traded company; (3) the price/earnings ratio that can be
obtained and how that translates into a potential stock price
and benefit to shareholders; (4) the location of the companys
customers; and (5) the potential for shareholder liquidity.
For example, many domestic Chinese companies have
elected to launch their IPOs on domestic Chinese stock
exchanges. The IPO process tends to be easier and less

MAY 2008 27

Special report

initial public offeringS

expensive than in the United States. Similarly, the annual

costs of legal and regulatory compliance required of public
companies is much lower in China. In addition, in 2006 and
2007, the dramatic rise of stock prices on the Shanghai and
Shenzen stock exchanges provided shareholders with
handsome returns on their investments. Finally, many customers were located in China or at least in Asia making an
IPO in China a beneficial undertaking.
Notwithstanding the above, overseas stock exchanges,
particularly the New York Stock Exchange (NYSE) and
National Association of Securities Dealers Automated
Quotation System (NASDAQ) in the United States,
remain attractive to most Chinese companies. These
exchanges have a long history with sophisticated institutional investors. They tend to have better liquidity and
less volatility. The entire public offering infrastructure is
more mature and functions at a higher level. The requirements for full disclosure, transparency and corporate
governance reduce investors risks and are seen by
sophisticated investors as very beneficial.

The emergence of China domestic stock exchanges

Recent explosion of domestic IPOs
In their brief history, Chinas domestic stock exchanges
were not initially an attractive financing option for most

private Chinese enterprises. The Shanghai and Shenzen

Stock Exchanges were formed in the 1990s as arms of the
Central government, not as places where sources of capital
could meet users of capital in the standard equity market
sense that western investors understood. The exchanges
were created to list State Owned Enterprises and sell shares
to outside investors thereby raising the value of the governments stake in these companies. To date, approximately,
two-thirds of the shares among domestic stock exchanges
listed companies are owned by the state. The securities regulatory system lacked clear rules and the enforcement mechanism was highly inconsistent. In addition, the investment
culture was immature. Western concepts such as return on
equity, price earnings ratios and the like did not command
mind-share among Chinese investors.
In recent years, however, Chinese domestic stock
exchanges have started to become more competitive with
overseas stock exchanges which have historically dominated world-wide capital markets. In 2007, 124 domestic
Chinese IPOs raised US$65.09 billion and averaged
US$524.91 million, exceeding the 118 overseas IPOs by
Chinese enterprises which raised US$39.745 billion. Outpacing overseas counterparts, the domestic Chinese markets attracted six IPOs with offerings of US$25.35
billion or more. Even Chinese companies backed by foreign VC/PE had an explosive IPO growth in the domestic
Chinese stock markets. Compared with the ten IPOs
listed during 2006, the 33 domestic IPOs of VC/PEbacked companies generated a 230 percent growth rate,
and yielded about twice the return of overseas IPOs in
2007. Goldwin Science & Technology for example,
debuted on the Shenzhen SME Board generated over a 30
times investment return for its investors. West Mining
the only VC/PE backed IPO on Shanghai Stock Exchange
during 2007 brought its lead investor a return of 26.96
times the investment.
Regulatory efforts to improve the
domestic Chinese capital markets
This explosive growth in IPOs on the domestic Chinese
stock exchanges has largely resulted from Chinese
governments regulatory efforts to keep such finance
transactions onshore and to maintain control over
Chinese companies.
On one hand, the Chinese government has enacted a
series of measures making it much harder for Chinese com-

28 ASIAN-COUNSEL

China IPOs the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

panies to establish offshore holding companies and discouraging Chinese companies from being listed on foreign
stock exchanges. VC/PE financings for Chinese companies have traditionally been structured offshore, using
Cayman and other offshore holding companies as financing vehicles. State Administration of Foreign Exchange
(SAFE) Circular 75 and subsequent regulations made the
use of such offshore holding companies very difficult.
Similarly, historically, IPOs of the best Chinese companies have occurred in Hong Kong or the United States.
This paradigm has been changed by the Regulation on
Merger and Acquisition of Domestic Enterprises by Foreign Investors (the 2006 M&A Rules) which deters Chinese companies from restructuring for the purpose of
conducting offshore offerings. These regulatory barriers
make overseas listings much more difficult and the trend
is to continue to limit such listings.
A parallel development is the effort of the Chinese
Government to implement a national strategy of building
mature and multi-level capital markets. From the middle of
2005 to mid-2006, China imposed a moratorium on new
domestic IPOs during which the domestic stock markets
were restructured to convert non-tradeable shares into
tradeable shares. Since the lifting of the moratorium, Chinese domestic listing activity has exploded (over 100 new
listings) and until the recent correction, the domestic
indexes have hit all time highs.
Furthermore, recent regulations provide an incentive
for more foreign investors to structure their investment
vehicles as RMB dominated domestic private equity funds.
The improvement of the approval process for listing on
domestic stock exchanges should make it more convenient
for VC/PE firms to sell their investments. Foreign private
equity investors are now looking at Chinese domestic
IPOs as a possible exit rout. IDGVC, SAIF, and other
investors have achieved high returns on investments on the
A Share market when certain of their portfolio companies
went public on the domestic A Share market.
The imminent launch of Chinas Growth Enterprise
Market (GEM) after nearly nine years of preparation also
may create additional opportunity for domestic Chinese
companies. On March 21, 2007, the Chinas Securities
Regulatory Commission (CSRC) released Initial Public
Offering and Administration Measures on Enterprises Listing on Growth Enterprises Market (draft rules) on its website. The draft rules for the GEM stipulated the conditions,

procedures for issuance, formation disclosure, supervision

and other matters. Growth ventures, start-ups in high-tech
parks, securities companies and their direct investment
branches and various investors have been optimistic
regarding the launch of the GEM. Most analysts envision
that China will see a growth in domestic IPOs after the
promulgation of the final rules by the CSRC.

Although management buyouts and

mergers and acquisitions are becoming
more and more common in China, most
growing Chinese companies still prefer
selling shares to the public through an
IPO over other fund raising or exit
strategies
James C Chapman, Partner
Nixon Peabody

Apart from the GEM, the launch of an over-thecounter (OTC) market and a market for trading corporate bonds are also underway. The State Council has
approved the establishment of the OTC market in Tianjin, which will also provide more access to the capital
markets for smaller private companies.
Current challenges facing Chinese stock exchanges
Although the viability of the Chinese Stock Exchanges has
dramatically increased, there are still significant challenges in
going public on a Chinese stock exchange. Foreign VC/PE
firms still see an IPO on a Chinese domestic exchange as problematic. Issuers, investors and intermediaries expect more
transparency for publicly traded companies. Foreign investors
still face problems with foreign exchange and significant tax
challenges. In addition, current Chinese law requires investors
to lock-up their shares for a significant period of time. Accordingly, the Chinese stock exchanges still do not meet the needs
of foreign investors which provide the majority of capital
for Chinese private companies.
In addition, recently the domestic Chinese stock
exchanges have suffered a major correction and values have
dropped 45-50 percent. As a result, the IPO activity has

MAY 2008 29

Special report

initial public offeringS

dramatically decreased. Compared to the number and

size of IPOs in the first quarter of 2008, the second quarter appears to be dramatically down. This is especially
true for VC/PE backed companies.

The use of foreign stock exchanges

for Chinese IPOs
Despite the impressive transactions that China has listed
domestically in the past few years, the market value of Chinese companies listed on overseas stock exchanges is still
larger than the market value of the companies listed on the
Shanghai and Shenzhen stock exchanges. Notwithstanding
the obstacles imposed by the Chinese Government, overseas
IPOs of Chinese companies continue to increase. In 2007,
there were 118 IPOs of Chinese companies on overseas stock
exchanges This is a substantial increase over the 2006 figure
of 32 IPOs, and the 2005 number of 37. Compared with
2006, and excluding the two mega-IPOs of the ICBC and
BOC, the amount of capital raised in 2006 was substantially
higher than in 2005.
The increase in competition among
overseas stock exchanges
All nine major overseas capital markets attracted qualified Chinese IPOs, including NASDAQ, NYSE, Hong Kong Main
Board (HKMB), Hong Kong Growth Enterprise Market
(HKGEM), Singapore Exchange (SGX), Stock Exchange of
Singapore Dealing and Automated Quotation Systems

(SESDAQ), London Alternative Investment Market (AIM),

Taiwan Stock Exchange (TSE) and Korean Securities Dealers
Automated Quotation (KOSDAQ). In 2007, the TSE, MOTHERS, and KOSDAQ attracted Chinese IPOs for the first time
expanding the financing venues for Chinese enterprises.
HKMBs leading role
Due to its proximity and shared historical ties, the HKMB has
been the first choice for the IPOs of most Chinese enterprises.
In 2007, HKMB continued to outpace other overseas stock
exchanges both in the amounts raised and numbers of IPOs. In
2007, 52 companies conducted IPOs on the HKMB raising an
aggregate of US$31.127 billion. The large offerings in 2006 and
2007 demonstrated that HKMB had become a global player
among major stock exchanges. For the first time in 2006,
HKMB ranked as the number 1 exchange among world stock
exchanges for total proceeds (US$46.1 billion raised).
United States stock exchanges scoring
in the Chinese IPO competition
The United States stock exchanges have had the advantages of
having the best liquidity and transparency, proper disclosure requirements, straightforward accounting rules and
other positive traits. As of the end of 2006, 41 Chinese
companies were listed on NASDAQ. For China venturebacked technology companies, NASDAQ is still the
preferred option for an IPO. US institutional investors
are very knowledgeable and are comfortable with tech-

Overseas IPO events and offer amount by market (from 2005 to 2007)
Market

2005

2006

2007

Offer
IPO Average
Offer
IPO
Average
Offer
IPO
Average
Amt (US$M) Events (US$M) Amt (US$M) Events (US$M) Amt (US$M) Events (US$M)
HKMB
19012.72
37
513.86
41284.14
39 1058.57
31127.38
52
598.60
NYSE
395.70
1
395.70
480.55
3
160.18
4490.51
18
249.47
SGX
201.83
20
10.09
1336.79
24
55.70
1987.84
26
76.46
NASDAQ
718.84
7
102.69
527.07
6
87.85
1469.10
11
133.55
HKGEM
74.74
8
9.34
227.49
6
37.92
255.58
2
127.79
TSE
0.00
0
0.00
0.00
0
0.00
191.09
1
191.09
AIM
62.09
2
31.045
130.42
6
21.74
135.43
5
27.09
MOTHERS
0.00
0
0.00
0.00
0
0.00
41.78
1
41.78
KOSDAQ
0.00
0
0.00
0.00
0
0.00
31.52
1
31.52
SESDAQ
23.94
6
3.99
11.55
2
5.78
14.56
1
14.56
Total
20,490.32
81
252.97
43,997.99
86
511.60
39,744.79
118
336.82
Source: Zero2IPO-China VentureDatabase

30 ASIAN-COUNSEL

Illustration: Johnnie Au

China IPOs the era of transition

By James C Chapman and Wanli Xu, Nixon Peabody

nology investing. Such sophistication lessens volatility the vast majority of the shares of the publicly traded comand improves liquidity. The NYSE historically has been pany. The most common exchange used for this technique has
the leading stock exchange in the world and lists many been the Over-the-Counter-Bulletin Board (OTCBB). Once
of the worlds largest companies. It has the highest list- listed on the OTCBB, successful companies seek to build a
ing standards and its corporate governliquid market in their stocks and move
ance rules are the toughest.
to a higher quality stock exchange such
Many domestic
United States stock exchanges have
as NASDAQ. Over the past five years,
Chinese companies
worked hard to attract more Chinese
There has been a tremendous resurIPOs in the past two years. NASDAQ
gence in reverse mergers in the US as
have elected to
has Chinese-speaking staff in Shanghai
institutional investors began investing
launch
their
IPOs
on
and Beijing and is waiting for approval
in companies that become public
to open a Beijing office. In late 2007,
through reverse mergers.
domestic Chinese
the NYSE received separate approval
The SPAC is a company with no
stock exchanges. The
from Chinese regulators to open a repreassets or business that conducts an
IPO process tends to
sentative office in Beijing. Most ChiIPO. Investors are willing to purnese companies looking to raise capital
chase the shares of the SPAC based
be easier and less
in overseas stock exchanges are midupon the reputations of the founders
expensive than in the
sized and looking to grow rapidly. They
of the SPAC and its purpose. Once
often find US stock exchanges as the
the IPO is completed and funds
United States
best alternative for not only attracting
raised, the SPAC seeks to purchase
Wanli
Xu
US capital but global capital as well.
an operating business. Currently,
Whether it is because of the size and
there are a number of SPACs which
Nixon Peabody
reach of the NYSE or the expertise with
have been formed to acquire pritechnology companies possessed by
vately held companies located in
NASDAQ, US exchanges are often being selected for China. The acquisition is usually completed as a share
IPOs over other foreign alternatives.
exchange and the holders of the Chinese company end
Outside forces have also driven Chinese companies to up owning shares of the publicly traded company.
US stock exchanges. Many institutional investors prefer a
listing on the US stock exchanges. Mainland firms hope that Conclusion
listing in a market known for tough regulations and strin- The Chinese domestic stock exchanges have matured
gent oversight will give them credibility with both global greatly in the past three years. Regulatory reforms, the introand domestic customers and business partners.
duction of new products and the Chinese Governments
efforts to discourage IPOs on foreign exchanges, have all
IPO Alternatives in the US Capital Market
bolstered the Chinese stock exchanges. Overseas stock
The US stock markets have not only been successful at exchanges continue to attract Chinese companies with
attracting Chinese companies interested in IPOs, but they better liquidity and a more mature investment culture. Each
have had success in attracting Chinese companies interested of the stock exchanges discussed in this articles have advanin alternative methods of going public. Currently, there are tages and disadvantages. In this era of transition, Chinese
two major IPO alternatives available in the US. These companies should carefully evaluate the best exchange for
include the reverse takeover or reverse merger and the their IPOs and plan far in advance. Careful analysis and
special purpose acquisition company or SPAC as it is com- thoughtful planning can make the difference between a
monly referred.
hugely successful IPO and failure.
A reverse merger is a transaction in which an operating
jchapman@nixonpeabody.com
company mergers with a publicly traded corporation that
wxu@nixonpeabody.com
has no business. By means of a share exchange or merger,
www.nixonpeabody.com
the shareholders of the operating company end up owning

MAY 2008 31