Hong Kong IPOs: Winner by default

Nearly 200 companies currently have live listing applications with the Hong Kong Stock Exchange (HKEx), a record high for the bourse. Much is made of Chinese technology players - spooked by regulatory uncertainty - axing plans for US IPOs and hot-footing it to the territory, yet it’s unclear to what extent this is behind the rising demand.

“We are certainly seeing more interest, but I don’t know if everyone is dashing to Hong Kong,” notes Vivian Yiu, a capital markets partner at Morrison & Foerster. “Everyone says people are coming here, but I think most are adopting a wait-and-see approach.”

Various other possible reasons are offered for the rise in applications, including a widespread expectation that mainland Chinese regulators will start pre-vetting small red-chip companies – which are controlled by mainland entities but incorporated overseas – seeking to list in Hong Kong. Some applicants are looking to get the jump on any formal implementation.

But wait-and-see is an appropriate mantra. While Hong Kong is the obvious beneficiary of restricted access to US markets – real or perceived – this is not reflected in the headline numbers.

Between January and June, HKEx contributed to a surge in global IPO activity, with 46 offerings generating proceeds of HK$213.2 billion ($27.4 billion), the largest-ever first-half total. Short video platform Kuaishou Technology led the way on HK$48.3 billion, but four of the 10 largest IPOs were secondary offerings by US-listed Chinese technology companies, including Baidu and Bilibil.

Then came Didi’s New York Stock Exchange (NYSE) IPO at the end of June and ensuing brouhaha as the ride-hailing giant was targeted by regulators for violating rules on data collection. Beijing later stated that companies holding large amounts of consumer data must obtain approval to list overseas.

The intervention – coming on top of a string of others targeting the technology sector – eroded investor sentiment and closed the US listing route for all bar a handful of smaller companies operating in less sensitive areas. The Hang Seng Index dropped 15% in the third quarter and local IPO activity was muted, with HK$75.3 billion raised.

Nevertheless, Louis Lau, a partner in the capital markets advisory group at KPMG China, is optimistic about the prospects for the fourth quarter, noting that it is the traditional peak season for IPOs.

“Momentum remains strong despite the third-quarter slowdown, so 2021 might match 2020 [when nearly HK$400 billion was raised] or slightly exceed it,” he says. “Not all the nearly 200 listing applicants will necessarily complete successful IPOs, but there is a big pool of companies trying. There will be activity in 2022.”

One Hong Kong-based investment banker gives a different perspective, suggesting that no company of size will seek to list before March 2022. “Anyone who goes now will be asked why they are doing it, and everyone will guess the answer – because they need the money,” he says.

Bigger is better

It is a matter of debate whether HKEx can, or indeed wants to, become a haven for a broad swathe of Chinese technology start-ups that would otherwise have gone public in the US. Concessions were made in 2018 to broaden the exchange’s appeal – pre-revenue biotech players and companies with weighted voting rights (WVR) structures were allowed to list – but with strict conditions attached.

Hong Kong now claims to be Asia’s largest biotech fundraising hub, with 33 listings by pre-revenue companies from the introduction of the reforms to June 2021. A further 19 have filed for IPOs. They are subject to stringent qualification and disclosure requirements, including the backing of a sophisticated investor, typically a VC firm specializing in healthcare or a leading pharma player.

Private equity-backed technology IPOs, meanwhile, have tended to be sparse yet large. This reflects HKEx’s decision to restrict the WVR exemption – as well as an exemption for pre-profit companies – to those that meet minimum standards in terms of market capitalization and revenue.

AVCJ Research has records of fewer than 20 listings by technology players with financial sponsors since WVR came into force. Xiaomi, Kuaishou, and Meituan account for about 80% of the aggregate proceeds. In the second quarter of 2021 alone, 10 China-based businesses – primarily technology players – raised $8.9 billion through IPOs in the US. The third quarter total was zero.

“If the most recent funding round was at the end of last year or beginning of this year, before the recent issues, even if the company listed today, would it get the valuation it was expecting? That is the major concern,” says Maurice Hoo, a partner at Morgan Lewis, commenting on the wait-for-the-US versus proceed-with-Hong-Kong dilemma.

NYSE hasn’t given up on China, emphasizing the depth and sophistication of its investor base, which can translate into healthy price premiums for companies able to tell a story that resonates with key market participants. Ample liquidity – NYSE’s daily trading volume of $130-150 billion is several times that of Hong Kong – and the prestige value of a New York listing are other selling points.

“It is pretty clear companies are being steered to Hong Kong, but it’s not clear what they will choose. NYSE will continue to pitch its case,” says a source familiar with the exchange’s thinking. The exchange declined to comment on its plans.

NYSE, like other interested parties, is in “wait-and-see mode,” but it isn’t sitting still. The Asia pipeline for the next two years is said to comprise about 100 companies, excluding China but including special purpose acquisition companies (SPACs).

Technology unicorns will feature prominently, with Southeast Asia and India expected to deliver up to 10 and five IPOs over the next 18 months. Meanwhile, there was a surge in inquiries from Korea following Coupang’s $4.5 billion NYSE IPO in March. It is no coincidence that the exchange’s Asia business development head is relocating from Hong Kong to Singapore, the source adds.

Time’s a healer?

Restoring the China-US channel involves compromise on both sides. The US Securities & Exchange Commission (SEC) responded to China’s enhanced approvals for overseas IPOs by ramping up disclosure requirements for US-listed Chinese companies using variable interest entity (VIE) structures, which give foreign investors exposure to restricted sectors, including technology.

At the same time, a years-long impasse between the US Public Company Accounting Oversight Board (PCAOB) and Beijing over audit inspections of US-listed Chinese companies took on a new edge this year with the passage of legislation that could mean non-compliance results in enforced delisting. The SEC recently approved a framework for identifying which companies are implicated.

“People in the US seem pessimistic about Chinese companies listing there. Another camp believes there will be some political compromise and the issues will be worked out. Investment banks are in the latter category, but then US deals generally move faster, there’s more certainty of completion, and they make larger commissions from them,” says Paul Boltz, a partner at Gibson Dunn.

J.P. Gan, founding partner of Ince Capital Partners, is among those anticipating an amicable resolution, although he claims that, as a VC, he is an optimist by nature. Gan notes that Chinese regulators have said they will continue to respect VIEs for overseas listings, while detailed guidance on data privacy has yet to emerge. With clear rules and a political thawing, IPOs will resume.

“Anyone looking at a 6–12-month horizon wouldn’t consider listing in the US, but beyond that who knows,” Gan says. This implies the most likely US to Hong Kong conversions will be relatively mature companies that have received several rounds of funding and perhaps have investors agitating an IPO.

Beijing Yuanxin Technology, operator of China-based online healthcare services platform Miaoshou Doctor, recently applied to list in Hong Kong. The company, which counts Ince as an investor, closed a $231 million Series F in August. Online audio platform Ximalaya abandoned its US IPO in September and filed in Hong Kong, with e-commerce player Xiaohongshu expected to take the same path.

Ximalaya is one of three China Creation Ventures (CCV) portfolio companies to kickstart Hong Kong listing processes in recent months, alongside Arrail Dental, a dental clinic chain, and Shukun, a developer of artificial intelligence (AI) technology used in medical imaging diagnosis. All have sizeable revenue of can demonstrate rapid revenue growth, says Wei Zhou, CCV’s founding partner.

“It’s like Hong Kong is in between the US and China. In the US, they are always looking for a big future, and if revenue or profit is small, that’s fine. In China, they want to see cash flow and profitability. Hong Kong is in the middle,” he adds. “Many Chinese companies have already achieved the threshold to list in Hong Kong. But will they choose to list there?”

There are various reasons why a business might not qualify for an IPO beyond financial performance, from suspicious related-party transactions to incomplete business permits to exposure to countries subject to trade sanctions. Hoo of Morgan Lewis has seen potential take-private transactions collapse after PE investors realized, on studying the target’s filings, that a Hong Kong relisting was unviable.

Sticking to principles

If Hong Kong and the US are both ruled out as IPO destinations, restructuring onshore to pursue a domestic listing is an option. Alternatively, a company could wait and raise more private funding. Asked about the prospect of joining a round when IPO plans have been thwarted, Ince’s Gan says it depends on business quality and whether he gets a better valuation to compensate for the risk.

Marcia Ellis, a PE and M&A-focused partner at Morrison Foerster, adds: “If these companies are not mature enough to be listed in Hong Kong, perhaps they should just wait. It’s not necessarily terrible. Thinking of the overall ecosystem, maybe it’s better if these companies wait for a while. Or maybe an onshore listing makes sense for them, especially if the trading multiples are strong.”

However, appetite for China’s Science & Technology Innovation Board – or Star Market – has been muted ever since Ant Group’s mainland-Hong Kong dual listing was canceled last year. Several VC investors claim that the spate of rejections across the mainland markets in the past two years has made companies reluctant to subject themselves to the scrutiny of a listing application.

Adherence to process and protocol can be a challenge in Hong Kong as well, especially when accustomed to a US system based on full disclosure and a trail of class-action lawsuits should misdemeanors emerge. Prioritizing retail investor protection, Hong Kong is proactive and paternalistic, constantly seeking to identify and neutralize potential problems.

This extends to the language in IPO prospectuses, with one industry participant expressing frustration at how phrases such as “best-in-class” are nixed from documentation for pre-revenue biotech companies for being too subjective. “They don’t like technical language and they don’t like adjectives that are standard in US biotech,” he says. “They just want to dumb down the language.”

Yiu of Morrison of Foerster points to this as evidence of a general emphasis on verification among regulators and sponsors in Hong Kong. Any claim of product preeminence will be scrutinized, often resulting in a request that the issuer provides proper context and supporting expert testimony.

There is little expectation of further change to smooth the path for high-growth companies. For now, broader forces are in Hong Kong’s favor, creating tailwinds that will bring China IPOs to the exchange without additional encouragement. Should this persist, any concerns about liquidity or valuation deficits might be removed, with CCV’s Zhou noting that “money always chases good companies.”

“I can’t see them relaxing the rules – the market has a high level of retail investor participation, and it isn’t mature enough,” says Lau of KPMG. “Hong Kong may consider setting up a new board targeting professional investors only with a relatively light touch vetting process that accommodates companies with smaller market caps. Or it could revamp the GEM board because there is a lack of interest in listing there. That has been discussed.”

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• Topics
• Greater China
• IPO
• Technology
• Regulation
• Advisory
• Hong Kong (China)
• China
• KPMG
• Ince Capital Partners
• China Creation Ventures