Another Shanghai surprise

Looking at the largest U.S. stock offerings this past year, it’s evident that without China, the American IPO market would be a drastically duller place.

China-based companies such as Acorn International, LDK Solar, Trina Solar and Xinhua Finance have collectively raised more than $1 billion via IPOs on U.S. exchanges this year. And with China’s economy booming, it would appear that U.S. investors are on a fast track to take their Chinese portfolio companies public. But a tangle of regulations in China is has thrown up a roadblock for any new U.S. IPOs by Chinese companies.

A law that took effect last September requires Chinese companies seeking to go public on overseas exchanges to obtain approval from China’s Ministry of Commerce. While many companies have applied for permission, it appears that none have yet received it, says Anna Han, an associate professor at Santa Clara University School of Law.

Home field advantage

Han sees the delay as a move by the Chinese government to try to bolster its domestic exchanges. “The idea is if you limit the number of companies going abroad to list, you then force them to look to the domestic market more,” Han says. She predicts that delays will persist for months, though probably not years.

The idea is if you limit the number of [Chinese] companies going abroad to list, you then force them to look to the domestic market more.”

Gavin Ni, CEO, Zero2IPO

Market data support Ni’s contention. Overall venture investment in China in Q1 was around $420 million, 26% higher than the same period last year, according to Zero2IPO. Chinese Internet companies, in particular, have been sought after by U.S. VCs, with social networking site, content delivery network ChinaCache, and matchmaking service each bringing in rounds of more than $10 million, according to Thomson Financial (publisher of VCJ).

Ni says the market for foreign venture capital investment in China is saturated, triggering escalating competition for hot deals. “It’s time for foreign VCs to slow down the pace,” he says.

That’s not likely to happen in light of all the new China-focused funds hitting the market. So far this year, Kleiner Perkins Caufield & Byers closed on $360 million for its first China fund, while Infinity Venture Capital raised $155 million for a hybrid China/Israel fund, and Softbank Asia Infrastructure Fund closed on $1.1 billion for its third fund.

Funds that began investing only recently are still years away from exits. GSR, which began investing from its first fund two years ago, probably won’t be thinking about IPOs until 2009 or 2010, Lim says, adding that it generally takes a Chinese company four to six years to go from its initial funding round to a public offering.

Additionally, it’s not as if Chinese companies that must stick to domestic exchanges are suffering. The Shanghai Stock Exchange’s SSE Composite Index has more than doubled in the past year, even after accounting for a recent pullback. Among Chinese investors, Han says, demand for stocks has been exceeding the domestic supply.

A lot of the VCs are thinking of their portfolio companies listing in China.”

Lip-Bu Tan, Chairman, Walden International

Taking stock

Twenty-seven companies launched IPOs on China’s Shenzhen and Shanghai exchanges in the first quarter, raising about $12 billion, according to Zero2IPO. About one-third of the companies going public in China and abroad had previously raised venture capital or private equity.

In comparison, 14 Chinese startups debuted on overseas exchanges in the U.S., U.K. and elsewhere in Q1, according to Zero2IPO. In total, the new offerings raised just over $2 billion.

“A lot of the VCs are thinking of their portfolio companies listing in China,” says Lip-Bu Tan, chairman of venture firm Walden International.

Still, U.S. will eventually need to take Chinese portfolio companies public on U.S. exchanges to return money to investors in their own currency. For a dollar-denominated fund, “listing on the domestic Chinese stock market is not particularly interesting,” Lim says. Even if the offering were successful, it would be difficult to take the money out of China and return proceeds to limited partners, he explains.

If and when Chinese regulators begin to approve foreign stock market listings for China-based companies, Han expects them to favor only certain sectors, such as consumer manufacturing. She expects the government to push for companies in many other industries—such as telecommunications, infrastructure, natural resources and Internet companies—to go public on domestic exchanges.

“I don’t think these rules are intended as a total block for listing abroad,” Han says. “Call it a filtering system.”