What a chaotic week we just had for U.S.-listed China tech stocks.
Last Friday, Didi’s announcement that it would delist from the New York Stock Exchange (NYSE) and seek a Hong Kong listing jolted the market, leading all U.S.-listed China tech stocks to plunge.
Last Thursday afternoon, the U.S. Securities and Exchange Commission adopted final amendments implementing the disclosure and submission requirements of the Holding Foreign Companies Accountable Act, requiring companies that fail to comply with the provisions to delist within three years.
U.S. regulators are not the only ones squeezing China tech stocks. Last Wednesday, Bloomberg reported that Beijing would ban companies with a variable interest entity (VIEs) shareholding structure from listing overseas. Hours after the report and before the U.S. markets opened, the China Securities Regulatory Commission denied Bloomberg’s report. Caixin’s report — published almost simultaneously — pointed out, in milder terms, that “The general supervision direction is to allow companies to make their own listing venue decisions and overseas listings for those VIE structured companies will not be completely halted with certain regulation rules applying to some industries.”
No Chinese tech company has pursued a U.S. listing since Didi was formally investigated on July 2. After the announcement of its delisting, Didi chose the Hong Kong Stock Exchange as its new listing venue. Meanwhile, more than 200 companies are in the process of applying for a Hong Kong listing, according to investment bankers. The truth is that Hong Kong has become the main overseas listing venue for Chinese companies.
Questions, suspicion and even denial have surrounded Hong Kong’s future as an international financial center since the National Security Law went into effect last June. Beijing has enormous motivation to buff up Hong Kong’s current position and willingness to lead Chinese mainland companies to Hong Kong.
Then comes the question: if China tech stocks have to delist from New York, is Hong Kong ready to take them all?
New York and Hong Kong, one market
When talking about capital markets outside China, Chinese people usually specifically mean New York, and they often categorize Hong Kong as an independent market. Even institutional investors tend to confuse Hong Kong and New York, as if there is just one market in their eyes.
Hong Kong is not an isolated market. Just like New York, London, Tokyo and Frankfurt, it is part of the international capital market, a naturally formed market in which institutional investors can buy and sell financial products via stock exchanges in countries and regions where currencies can be freely converted. Hong Kong and New York are essentially one market, and the key players are essentially the same.
Who are these players?
The majority of the investors in the international capital markets are U.S. dollar funds managed by institutional investors with a significant portion of their capital coming from developed countries, including the U.S. and the nations of Europe. They have a dominant market position and pricing authority. Capital from the Chinese mainland, in the foreseeable future, will only play a supplemental role and won’t replace them.
Risk management of institutional investors is being applied globally in each of the markets. China sovereign risk requires a risk premium or valuation discount. In fact, the Hong Kong market has already seen a few IPOs price at less than half of their expected value.
If they believe China is not investible, no investments can be executed in any market, either New York or Hong Kong.
These being said, to the surprise of mainland Chinese, the so-called international capital market implies that the same group of institutional investors execute transactions under the same risk management rules in different exchanges. Hong Kong and New York are essentially one market. Any assumption that a Hong Kong listing can be a perfect substitute for a U.S. listing reflects a lack of understanding of the capital market.
In addition, Hong Kong has its own characteristics.
What makes Hong Kong different
To start with: Low liquidity.
This is the first impression that most investors have of Hong Kong. In fact, the liquidity of the Hong Kong Stock Exchange is of a completely different magnitude than that of stock exchanges in the U.S.
On Dec. 6, the Hong Kong bourse announced a daily average turnover of HK$171.5 billion ($22 billion) in 2021 as of the end of November. In the U.S., a $400 billion a day can be easily be achieved.
Cathie Wood, an investor celebrated for her ambitious bet on tech stocks, owns American depositary receipts of Tencent Holdings Ltd., rather than the shares traded in Hong Kong. This is a very telling example.
Superior liquidity makes trading much easier in New York than in Hong Kong. When investors can easily make transactions in the U.S., they aren’t very willing to switch to Hong Kong. So, why bother?
On the other hand, Hong Kong data show that 15% of stocks contribute to 83% of market liquidity. The top 20% most traded stocks contribute to over 90% of liquidity. Apparently little attention has been given to mid- to small market cap companies. Indeed, any company with less than a $3 billion valuation has hard time attracting investor eyeballs.
Given the prevailing risk premiums, discounted valuation and low liquidity, some founders and investors, when celebrating their Hong Kong IPOs, should be ready for a bumpy road ahead for their exit.
Reasons behind the low liquidity
An easy explanation is that institutional investors allocate far less capital to Hong Kong than that to New York. Global investors see the U.S. exchanges as their first choice.
Some Chinese tech companies listed in the U.S. are already among the largest in the world in terms of market cap. Their delisting and entering the Hong Kong exchange, like sharks in a small pond, would suck up liquidity and pose a threat to midcap and small cap stocks and the exchange itself. For example, Alibaba Group Holding Ltd. witnessed turnover of $3 billion after the market opened on Dec. 6, an impossible feat in Hong Kong.
The more than 200 prospective IPOs lining up in front of the Hong Kong exchange has worried investors. Portfolio managers tend to consider the few large IPOs while ignoring midsize and small IPOs. “Friends and family” deals are widely expected as their IPO books are covered by capital from affiliated parties. Investment banks usually shy away from these deals as they value their brand names much more than IPO commissions.
Likes and dislikes
Hong Kong investors usually prefer asset-heavy companies with good profitability and strong dividend capabilities, such as those in the financial, real estate, consumer and retail industries. Indifference to the new economy and low tolerance for money-losing companies are their signature.
For example, they have got used to the notion that consumer companies should be profitable and would be startled at those so-called new consumer companies with valuations in the billions and an unknown path to turning a profit. Investment banks, eager to introduce them to the market, might find them a hard sell.
Traditionally, most of China’s tech companies go to the U.S., and only a few end up in Hong Kong, leaving investors in the city to further strengthen their established stance.
With too many prospective IPO companies in line, the Hong Kong exchange is seriously understaffed, making the traditional six to nine month IPO execution time much longer.
And don’t forget valuations. Hong Kong-listed tech companies usually have a valuation haircut when compared with similar companies listed in the U.S. Investors are emboldened by the U.S. market’s capital sufficiency, better investor protection and rigorous regulations. This is an invisible part of valuation as well.
And lastly, one most crucial issue has been overlooked: weighted voting rights.
Weighted voting rights
Weighted voting rights were first introduced by HKEX a couple of years ago after Alibaba chose New York over Hong Kong. Their purpose is crystal clear — attracting China’s large tech companies to make secondary listings.
The Hong Kong exchange has never intended to offer weighted voting rights to small and midsize companies.
The bar for revenue and market cap is not hard to meet, however. The definition and recognition of “innovative enterprises” is very subjective. To put it bluntly: if HKEX thinks you are an innovative company, then you are one.
For example, weighted voting rights were offered to YumChina as if YumChina was an “innovative” company. The reason? KFC and Pizza Hut customers use mini-programs to order food. This is absurd.
It is quite normal for founders of new economy companies to hold around 30% of their companies’ shares after several rounds of financing. Without weighted voting rights, these companies would become de facto owned by institutional investors once they listed. Hostile takeovers are very much anticipated, just like those in the U.S. market. We don’t believe many founders are mentally prepared for this.
With all those factors in mind, everyone should make their own judgment about whether Hong Kong is ready to accept all of the Chinese tech stocks that end up delisting from New York.
Amid the strategic competition between China and the U.S., China’s tech stocks are part of the common ground that both countries have an interest in. Maintaining the status quo will benefit China’s tech industry, and ultimately, China-U.S. relations.
Liao Ming is the founding partner of Prospect Avenue Capital, a growth capital fund focusing on China’s technology sector.
Editor’s note: The Chinese version of this commentary was published on Tuesday, which stirred strong debate within the finance community.
Read more Opinion: Don’t Underestimate Hong Kong’s Potential as a New Home for U.S.-Listed Chinese Stocks
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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