GUEST POST: Why Privatizing Chinese Stocks Have Become Hostages of the Moment

By Peter Halesworth

China’s bubbly stock markets have percolated into US exchanges, helping to raise New York-listed Chinese stocks that are reawakening after years of neglect. The Nasdaq Golden Dragon China index (Nasdaq: HXC) is up approximately 70 percent since 2013.

Yet something odd is happening on the way to this bull market. Managements of many of these companies are deciding to de-list from the US to pursue new IPOs in China. Despite the positive signals, 21 companies have announced since March that they have received proposals to privatize and de-list from the US exchanges.

Drowning out the positive signal from US markets is the siren song of surreal valuations of Chinese stocks listed in Shanghai and Shenzhen. Company managements are plotting to buy out investors in the US at a low price and, according to their scripts, sell out at a higher price in China.

This seems to be entirely appropriate behavior if you are a trader or hedge fund manager seeking capital gains. For managements of public companies, it looks like a sudden lunge to attempt market timing. It exposes how blinded managements are by quick gains that may be at best, temporary, and, at worst, illusory.

These departing companies may see themselves as hai gui (sea turtles) triumphantly returning home to domestic stock markets. Instead they may become less successful than hoped as hai dai, or seaweed.

Many of the departing managements are hostages of the moment. They are trapped in a fantasy that China valuations will remain at these high levels until they come home for their IPOs.

Lost Benefits

By choosing to privatize, they are also losing out on many benefits that international listings bring. Those include the international standing that comes with a US listing, which can help to attract international customers. They also lose out on the premium that comes from being listed on an international market. And they lose access to western investors and capital markets that are usually more experienced than their Chinese counterparts.

Admittedly it has been a struggle for smaller Chinese companies to gain recognition from U.S. investors. In China’s rally, it seems the underlying assumption is bulled-up Chinese investors will buy any stock. However, the behavior of the departing companies, with more than half opportunistically offering buyout prices less than the US IPO price, and measly premiums with their bids, has been well-spotted by investors in China.

On the popular Chinese stock community web site Xueqiu.com, some Chinese investors are surprisingly wagging their fingers at these managements for their behavior, describing it as “disgusting” and “immoral.” When the time comes for these companies to complete this market-timing fantasy with an IPO in China, the managements may be surprised to find local investors unwilling to play the part of the Greater Fool.

Meanwhile, the damage to the reputations of these companies will have already been done. The market-timing fantasy of the departing managements starts to wobble right from the start. The valuation of these companies will be discounted due to questionable corporate governance, judging by the comments of some Chinese investors.

Not all Chinese companies listed in the US can be Alibaba (NYSE: BABA) or have the global vision of its Chairman Jack Ma. But there is another option to close the valuation gap that some US-listed companies are pursuing and is worth considering.

List a subsidiary in Shenzhen or Shanghai. This is a way to get a market value on a significant or growing part of the company that, with recognition from Chinese domestic investors, could positively impact the company’s overall valuation. A few Chinese companies are doing this, and it could offer all of us the best of both worlds by maintaining an international standing while providing access to Chinese investors.

Peter Halesworth is the founder and managing partner of Heng Ren Investments, a Boston-based fund investing in Chinese stocks (http://www.hengreninvestment.com). He can be reached at admin@hengreninvestment.com.