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US market falls out of favor with Chinese firms

BEIJING -- Where is the best place for Chinese Internet companies to go public? E-commerce titan Alibaba Group Holding gave its answer last year, when the company chose the U.S. for its record $25 billion initial public offering.

     But things are changing rapidly. A number of overseas-listed Chinese companies are considering bidding farewell to foreign exchanges, after missing out on an unprecedented stock boom at home. The main Shanghai index is up more than 50% this year, while the Shenzhen composite index has gained more than 110%.

     The Chinese stock markets are soaring despite sluggish domestic and external demand for Chinese products, providing a valuable platform for companies to raise money. The government also hopes to see the market do well amid slower economic growth. Recent editorials in the People's Daily, the government's mouthpiece, have said that the stock market should rise with steady gains and that a so-called "slow bull" market is sustainable even if there are short-term corrections.

     Companies likely to heed the call of the A-share market are primarily second-tier technology-related companies, which have long complained of being undervalued by foreign investors. Many say that it is easier for Chinese investors to understand their business models.

     Reforms of the country's rigorous securities law -- which include a promise to abolish the requirement that all companies seeking an IPO must have a track record of profitability -- will also make it easier for them to return to China.

     Such requirements are the primary reason technology companies, usually taking years to turn a profit, chose the U.S. or Hong Kong, often using a complex and risky series of contractual agreements called variable interest entities (VIEs) to circumvent Chinese restrictions on foreign ownership in sensitive industries. The U.S. allowance of a two-tier shareholding system -- which gives company managers more voting rights -- is also a factor behind the successful U.S. IPOs of Alibaba, e-commerce site and Chinese search engine operator Baidu.

     Antony Dapiran, a partner at law firm Davis Polk & Wardwell in Hong Kong, said that the streamlining of the mainland China IPO process is clearly the policy intention, and that will mean that it is more practical for these companies to undertake domestic listings.

     Focus Media Holding, an advertising company that delisted from the Nasdaq two years ago, said in May that it would instead trade shares on the Shenzhen Stock Exchange through a reverse takeover. The company quit the U.S. when its shares languished following short seller Muddy Waters' accusations of fraudulent practices, which it denied.

     Shanda Games, an online game developer, is delisting from Nasdaq after it accepted a $1.9 billion private buyout proposal in April 2015. While the company has not announced any plan to list in China, there is speculation that it could launch a backdoor listing via Shenzhen-listed Ningxia Zhongyin Cashmere, Shanda's parent company after the privatization. A couple of other gaming companies that have been taken private are also expected to do the same -- Perfect World, bought out by Chairman Chi Yufeng in a deal valuing the company at roughly $1 billion, and Giant Interactive Group, which last year was privatized in a deal worth about $3 billion.

     Apart from gaming companies, other tech businesses are getting privatization offers from China which could lead to an A-share listing in the future. Nasdaq-listed Sungy Mobile, which provides mobile Internet products, in April received a preliminary privatization proposal from its CEO and chief operating officer. Chinese online dating platform International, also listed on the Nasdaq, in March received a similar proposal and has formed a special committee to evaluate the deal. Xueda Education Group, a provider of tutoring services, also received a privatization offer in May from Xiamen Insight Investment, a Chinese company listed in Shenzhen.

     "Now everyone wants to know if it is the right time to list instead in China," said Guo Kejun, a partner at Chinese law firm Zhong Lun, who said he gets a lot of inquiries about relisting in China.

     The Chinese authorities are also tightening the rules on VIEs, which could force U.S.-listed VIEs to change their domicile. In a draft legislation that the country's Ministry of Commerce unveiled in January, regulators are proposing to make a distinction between VIE companies controlled by Chinese entities and those controlled by foreign owners. Those considered foreign could be barred from operating in sensitive industries.

     In fact, all eight Chinese technology IPOs in the January-March period took place on domestic exchanges, according to PricewaterhouseCoopers. Zhang Wei, a partner at the Beijing office of venture capital firm Matrix Partners, said in a May forum that 40 of 230 firms the team has invested in are undoing their VIE structures to prepare for China listings.

     Those companies which have listed in China recently have enjoyed strong demand from investors. Beijing Baofeng Technologies, an online entertainment company which listed in Shenzhen in March, saw its shares rise by the daily maximum limit of 10% every day until earlier May. The stock fell after Leshi Information & Technology alleged on May 15 that Baofeng infringed on its copyrights, but the company's shares are still trading at more than 250 yuan, or 240% of its listing price, giving the company a market capitalization of 30.5 billion yuan ($4.92 billion).

     Focus Media could be valued at about 45 billion yuan when it debuts in China, almost three times of its U.S. market capitalization in 2013, a May 20 regulatory filing showed.

     Yet there are concerns that the Chinese stock markets are getting too frothy, and such high valuations could not be sustained when companies are done unraveling their VIE structures. The process could be quite time consuming as founders and their foreign investors hash out a price for the deal. There are heavy value-added taxes which can amount to several hundred million dollars, enough to deter some from returning.

     Dapiran warned of the likelihood of more fraud as regulators lower the threshold for listing. Paul Gillis, a professor of practice and co-director of the international MBA program at the Guanghua School of Management at Peking University, said he wouldn't be surprised to see "a sizable correction sometime soon" in the A-share market.

     In the long run, however, the Chinese markets could evolve into the most attractive option for Chinese companies, said Gillis.

     "The Chinese stock market is maturing rapidly and that expansion is going to continue," he said. "I think 15 years from now, all Chinese companies would list primarily in China, and that includes Alibaba and Baidu."

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