February 22, 2012
Between 2005 and 2010 dozens of Chinese companies chose to become publicly traded in the U.S. by engaging in a reverse merger (RTO). Unfortunately, since 2011 the market value of most Chinese stocks that are listed in the U.S. has declined while the costs of being a public company have increased. This is largely due to the wave of short sellers who started to question the financial statements of Chinese companies, which led to a sell off of Chinese stocks by foreign investors, increased scrutiny by U.S. regulators and increased costs for professional services, such as lawyers and auditors. Hostility toward Chinese companies has led many Chinese managers to question whether or not they should remain public in the U.S. This article will discuss the costs and benefits of remaining a U.S. public company.
The reasons for becoming public at the time were usually: to raise capital; to create liquidity outside of China for Chinese shareholders; and the prestige of having your company listed in the U.S. The reason most companies chose RTO as the preferred method to become public was that it was much faster and less expensive than a traditional initial public offering (IPO). Most of these companies accomplished some of their goals in connection with the RTO. They were able to raise some money, although usually not as much as they had hoped. They did get some recognition with customers, suppliers, banks and government officials for being a U.S. public company. Some even got some liquidity for their share ownership in the U.S. markets. The benefits discussed above still remain as the primary benefits of a public company. Although the recent lack of confidence in Chinese company stocks has somewhat dulled these benefits, it is likely that Chinese companies that remain public and invest in corporate compliance and governance, as well developing an effective investor relations strategy will be able to prosper as investors and regulators realize that there are some very good Chinese companies that remain listed in the U.S.
The costs of being a public company, however, will continue to rise in the near term. Professional fees, particularly from auditors, have risen as the perceived risks of auditing a Chinese company have increased. The same is true of independent directors and the cost of director and officer insurance, which they require in order to join a company’s board of directors. Increased scrutiny raises the risk that Chinese public companies may have to spend additional capital for regulatory and/or class action defense. As a result, In order to realize the benefits of being a public company, Chinese companies will have to work even harder to meet U.S. and international standards of corporate compliance and governance. This will also mean hiring additional staff with experience in U.S. GAAP and IFRS accounting and paying for increased training of existing staff. Finally, Chinese companies should expect to spend more money for investor relations as most investors will have a negative first impression of a Chinese listed company, particularly one that became public through an RTO. Unfortunately, Chinese companies will simply have to work harder and expend more capital than the average non-Chinese public company to prove that they are good corporate citizens; at least until the market begins to regain confidence in Chinese companies and their financial reporting.
Managers of Chinese companies listed in the U.S. should carefully weigh these costs and benefits in determining whether to remain publicly listed in the U.S. To a large extent, however, their decision will depend on the company’s current situation. For example, a company that only recently became public, which is at least 90% owned by insiders and has less than 300 shareholders will be able to go private much more quickly and with less expense than a company that has been public for several years and has already developed a large base of non-affiliated shareholders. Likewise, the latter company may already have in place the personnel and expertise necessary to maintain their U.S. listing and, therefore, the cost of maintaining the public listing will be significantly less than the cost of going private. Managers should also review the current market for financing in their particular sector. Companies that are in a business sector that is experiencing high growth may find it easier to raise money publicly and therefore will be willing to bear the greater cost of remaining public. Conversely, companies experiencing slow or no growth may not want to make the additional investment necessary to remain public as the returns may not justify the investment.
In our next two articles we will discuss when and how a company can legally cease public reporting in the U.S. (go dark) and how to a company can go private.