At times it seemed that bankers working on Chinese listings in the US in 2011 could do nothing right. Those deals that traded exceptionally well on their debuts brought criticism from clients for mispricing, and even threats of lawsuits. Nearer the end of the year, when many Chinese companies plummeted in the secondary market, bankers were criticised with pushing ahead with deals regardless of the conditions.
It was undoubtedly a tough year to work on the US listings of Chinese stocks. The same factors that hit sentiment in other markets the European sovereign debt crisis and the downgrade of the US, among others also damaged the confidence of equity investors. But Chinese issuers in particular had another problem: the question of corporate governance refused to go away.
Independent research firm Muddy Waters published a scathing report on Sino-Forest Corp in May. Sino-Forest moved quickly to defend itself, denying the analysts allegations but also setting up an independent committee to look into them for good measure. But the damage had already been done. Sino-Forest plummeted in the secondary market; a swathe of other Chinese stocks fell alongside it.
This was not the only thing that caused investors to back away from the market. The issue of variable interest entities (VIEs) also became more prominent at the start of 2011. Chinese companies tend to use VIEs to list offshore, signing contracts between the listed company, which is often a shell, the VIE and the company itself. But when online retailer Alibaba transferred its payment service, Alipay, away from its VIE in May, causing a fall-out with major shareholder Yahoo, investors started to question how safe the structure really was.
These two incidents damaged confidence in Chinese companies in markets around the world, but they particularly hit internet stocks listed in the US, since they coincided with fears about another, albeit more contained, dot-com bubble in the North American market, one largely limited to Chinese companies.
Chinese firms were able to pull off some very aggressive valuations over the course of last year. Renren, the social networking site, raised $743m from an IPO in May that valued the company at 74 times 2010 earnings. The valuation did not stop there, with the stock rising 30% on its first day. But investor sentiment towards the sector gradually turned, and by the end of December Renren was trading at a 75% discount to its IPO price.
Chinas regulators are starting to look more closely at the VIE structure but no concrete or workable resolution has yet emerged. That leaves bankers forced to field the same questions they faced last year and with no clear answers.
"Investors are actively seeking clarification on the legal validity of VIEs," says Rupert Mitchell, head of ECM syndicate, Asia Pacific at Citi. "The alternative red chip process [listing the actual Chinese company] is a significantly more lengthy and regulated route for issuers."
Bankers disagree about the future for Chinese companies listing in the US and how long the negative sentiment towards them will last. Some point to the successful $174m listing of online video company Tudou.com at the beginning of August as a sign that certain hot deals will be able to re-open the market. But it might be wise for some Chinese companies to rethink their corporate governance strategy, particularly taking more care over the composition of their board, says Mitchell.
There is one silver lining for ECM bankers. Asian investors have started to buy US IPOs from Chinese companies more frequently, and they could be a big source of demand this year. Several deals in 2011 were already covered from the Asian part of the roadshow before they even reached the US, say syndicate bankers.
There is also a chance that the poor performance of Chinese stocks in the second half of last year will convince investors to return to the market, acknowledging that many companies are now trading at or even below fair value.
"Most small cap Chinese companies suffered last year but many of them were still delivering strong earnings and these are where the opportunities are," says Raymond Chan, chief investment officer at RCM Asia Pacific, part of Allianz Global Investors."Usually these types of companies trade on high price to earnings multiples but they have moved down to single digits and now look cheap. These names wont perform in the near term because growth in China is slowing, but over the next 12 to 24 months we are confident these names will perform well for us."