Tech IPOs: An issue of control

Alibaba Group spent weeks lobbying Hong Kong regulators to permit its bespoke IPO structure. The company wanted to consolidate power within a group of 28 partners, including Jack Ma and Joe Tsai, the executive chairman and executive vice chairman, respectively, allowing them to nominate a majority of board members even though their combined post-listing equity stake would only amount to 10%.

It was at odds with Hong Kong Stock Exchange's (HKEx) traditional "one share one vote" system, which favors the majority shareholders, but Ma still made a strong pitch.

"This is not a mere profit sharing mechanism, nor is it a vehicle of power to exert greater control over the company; rather, it is a system that provides a driving force within the company," he said in an email to HKEx and the Securities and Futures Commission (SFC).

He added that if no compromise could be reached, Alibaba might instead opt to list in New York, where the bourses permit a dual-class share structure allows the founders of Google and Facebook, for example, to control their boards.

HKEx CEO Charles Li responded in a blog post, saying he was open to change, provided the discussions aren't rushed. This was effectively a rejection of Alibaba's proposal, denying Hong Kong bragging rights over a landmark Chinese internet IPO that could value the company at as much as $120 billion.

VC investors are looking on with interest. Mechanisms designed to allow the founder to retain control of his company are popular in the tech space globally. An exchange's tolerance of these approaches can therefore influence the number of tech stocks that trade on it.

Fair play

Compared to US bourses, which allow a variety of listing structures including limited partnerships and limited liability companies, Hong Kong is indeed conservative.
Regarding the Alibaba proposal specifically, David Neuville, a Hong Kong-based partner at law firm Cadwalader, describes it as a provision that would likely be written into the company's articles of association, granting certain rights to the partners on board composition.

While the effect is similar, the approach is differs markedly from the US dual-class structure, where one class is the standard "one share one vote," and the other offers multiple votes per share.

"There are other types of structures or ways of trying to accomplish the same objective. The point is the Hong Kong Stock Exchange, in the case of Alibaba, basically said ‘We don't like any of them,'" Neuville adds.

Entrepreneurs like them because they address concerns about being acquired by rivals via the public market. In the ruthlessly competitive Chinese e-commerce space, a company could cause a huge amount of trouble for a competitor by accumulating a 30% stake in their business from small-scale public shareholders.

However, J.P. Gan, managing partner at Qiming Venture Partners, argues that these structures are unlikely to gain traction beyond mature markets. The presence of a dual-class structure can undermine valuations while institutional investors might refuse to participate because they would have reduced voting rights.

"I would oppose such structures - it's not fair on shareholders - and most IPO sponsors would oppose them as well," says Gan. "It has only happened in large IPOs like Facebook, which attracts investors anyway because they see it as the next big thing."

It is worth noting that corporate structures alone do not dictate where a company lists. The US is perceived as a good venue for technology, thanks to its sophisticated institutional investors and strong analyst coverage.

Hong Kong is almost the polar opposite. High-growth tech stocks are also perceived as high risk and the regulator plays a much more active role in protecting investors, for example by refusing listing applicants that don't have a track record of profitability. In this context, tech firms often favor the US disclosure-based system over Hong Kong's merit-based approach.

"Hong Kong and the US follow fundamentally different regulatory philosophies," says Maurice Hoo, global leader of the private equity practice at Orrick. "The US regulator focuses on accurate and complete disclosures of material information. Even for companies with legal and financial risks and strong anti-takeover measures, they would not prevent them from listing, but would let the investors make their own investment decisions."

Uncertainty in America

However, US investors have yet to overcome the crisis of confidence in Chinese mid-cap stocks sparked by the emergence of financial irregularities among a number of companies. Only two private equity-backed Chinese firms have listed in the US so far this year - LightInTheBox and Montage Technology - well short of the 15 that went public in 2011.

"As a VC investor, we are more focused on whether we can exit our investment with fruitful returns," says Jixun Foo, a partner at GGV Capital. "Choosing a listing venue is actually the company's call. US bourses are still one of the main consideration as we believe US investors are becoming more rational in evaluating Chinese internet companies."

As for Hong Kong, the jury is still out. Tencent Holdings, now one of China's biggest internet companies, went public in the territory nine years ago with the stock debuting at HK$3.50; it is now valued at more than 100 times that amount. Kingsoft and NetDragon Websoft have also performed reasonably well.

Forgame Holdings, which is backed by TA Associates, Qiming and Ignition Capital Partners, is targeting a $222 million IPO in Hong Kong, in part because local investors are more familiar with the Chinese online gaming market. 

If the regulators want to capitalize on this sentiment and attract more tech listings, they might have to consider easing the rules.

"The exchange is unwilling to be flexible at this point and it could push some companies in different directions, such as towards the US," says Cadwalader's Neuville. "In the long term, HKEx will have to think about its position because the present one isn't particularly useful in developing the importance of the exchange."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• North America
• Exits
• Venture
• Exit
• IPO
• China
• USA
• Qiming Venture Partners
• Venture
• Alibaba Group
• TA Associates
• Tencent