'Back door' closing on ersatz stock listings
After Qihoo 360 Technology Co delisted in New York in 2016 and did a 50 billion yuan (US$7.8 billion) asset swap and share deal with Shanghai-listed elevator maker SJEC, it levered itself onto the Shanghai Stock Exchange in what is called a “back door” listing.
The biggest reverse takeover in three years on the Shanghai exchange prompted speculation that the market regulator might take a more benign view of such listings, even after the China Securities Regulatory Commission clamped down on the purchase of so-called “shell” companies to gain listings in June 2016.
The practice was especially popular with Chinese companies that had listed in the US, only to watch valuations on the domestic market rise above those on overseas markets. Many sought to relist on the mainland.
However high expectations ran after software specialist Qihoo listed under the SJEC ticker, no floodgate was opened. It seems that where discretion is exercised, only companies playing a vital role in mainland government policies, such as advanced technology development, stand much of a chance to squeak through.
"The Qihoo case was an icebreaker for leading tech firms,” said Song Qinghui, an independent economist. “While we might now expect to see a succession of bellwether firms listing on the A-share market, via either ‘back door’ listings or by IPOs, non-techs firms can expect that door to remain firmly shut. Only those that play a complementary role in mainland development may get approval."
Qihoo 360’s success has been attributed to its leading role in Internet-related national security software– a subject dear to the hearts of China’s leaders. But it’s also obvious that each application will be considered on its own merits and technology in a business name doesn’t necessarily guarantee a free pass.
In the past 18 months, a clutch of former US-listed firms, including Chinese property website Fang.com, information technology provider iSoftStone and Shanda Games have all failed in their attempts to relist on the A-share market.
According to Wind Information, the realm of “back door” listings last year showed a definite cooling trend after two years of strict oversight. Only six companies applied last year, down from 47 in 2015 and 19 in 2016.
Of the 2017 applications, only two passed regulatory scrutiny, one was still in progress at the end of the year, two were terminated voluntarily, and one was rejected outright. A failure rate of 50 percent compares with 34 percent in 2015 and 42 percent in 2016.
"We focus on supporting high-quality overseas listed Chinese enterprises of a certain scale and with core technologies that are in line with the strategic development of national industries," said Gao Li, a spokesman for the regulatory commission.
It’s clear that the welcome mat to return to the A-share market is being reserved for only select companies. They need to show that they are contributing in a significant way to industrial transformation and upgrading. Companies whose main objective is to skirt regulations hardly stand a chance.
“Stricter regulation makes it more difficult for companies to launch ‘back door’ listings, and the cost of purchasing ‘shell’ companies is rising,” said Shen Jie, a partner of PwC China.
The new policy is the strictest yet to look at how material assets of a company are restructured and funds are raised ahead of listing applications. It also prolongs the lock-up period that prevents shareholders from cashing in on high valuation shares when they first hit the market.
Five IPO applicants with so-called “variable interest entity” structures, where an investor holds a controlling interest not based on a majority of voting rights, were also rejected by the regulatory commission.
Variable interest entities generally involve Chinese firms and foreign venture capital funds that set up offshore vehicles to sign contracts with Chinese firms via one or more foreign investment subsidiaries in China, giving effective control of the companies to offshore entities.
"A series of regulatory policies, including new rules of restructuring and re-financing, have cooled the earlier booming market for mergers and acquisitions, and restructuring is no exception,” said an investment banker who advises financial institutions. “As more regulation comes into play, ‘back door’ listings will become increasingly difficult as far as approval is concerned.”
The speculation fervor of investors toward new listings related to “back door” listings seems to have cooled.
As for Qihoo, SJEC’s elevator and escalator business has been spun off and the shares have had a wild ride this year, often hitting the daily movement limit of 10 percent. The shares rose 10 percent on the first trading day of this year, then dropped 9.45 percent two days later. They last traded at 48.64 yuan, down 3.82 percent since January 2.