China's next IPO tidal wave
"An American listing not only stands for freedom, it is the dream come true."
The much-anticipated listing of Chinese e-commerce giant Alibaba early in 2014 will not take place in China, but that won't dampen investor enthusiasm for a frenzy of new initial public offerings when Chinese regulators finally lift the 14-month freeze on domestic IPOs.
The floodgates could open as early as January, with more than 760 companies lined up to test investors' appetite for Chinese companies. "There's been a lot of backup for companies wanting to go public," says Hurst Lin, general partner at DCM, a U.S. venture capital firm. "With the reopening of the IPO window, there will be a flurry of new listings."
Last month the China Securities Regulatory Commission issued new guidelines that are much more market-driven, and less dependent on the discretion of Chinese regulators. "What they're talking about is going to a system similar with the U.S." says Paul Gillis, a professor at Peking University's Guanghua School of Management. "You clear your IPO with the regulators; you let companies to go to the market when they choose to."
In the past, regulators judged whether companies were ready to go public in a process that could involve 10 steps and several years.
The IPO channel was shut down in October 2012 after a sharp decline in share prices and reports of fraud and misleading accounting. Up to then, Greater China (including Hong Kong and Taiwan) had become the world's largest IPO market, reaching $132.8 billion raised in 2010 before dropping sharply to $29.4 billion in 2012, according to a PricewaterhouseCoopers report.
The new rules reflect a promise by China's new leadership to loosen government controls on the economy. Under the old system, regulators often favored poorly run state enterprises while smaller private companies could wait years for approval.
"The new rules are a good step towards a system in which firms that meet the standards can go to the stock and bond markets," says David Dollar, an expert on the Chinese economy at the Brookings Institution in Washington. "Up until now regulators have had a lot of discretion about what IPOs and bond issues could go forward. "
(Read more: Chinese IPOs: Hot, hot, hot!)
"With the reopening of the IPO window, there will be a flurry of new listings."
"The new guidelines and the reopening will be good news for foreign investors who want to cash out of Chinese companies, Lin says.
DCM, a Silicon Valley venture capital firm with $2 billion under management has invested in 30 Chinese companies, making the firm a "moderate" investor in China, according to Lin. "We have institutional investors who want to get their money out. It provides exits for investors."
Some observers say that regulators were prodded to issue the new guidelines by Alibaba's decision to forgo a Chinese exchange for an IPO in the U.S. that could raise as much as $100 billion. But foreign investors say not all IPOs are suited to the Chinese domestic market.
Lin says Chinese Internet companies want go offshore because better analyst coverage and more companies to compare to deliver better valuations. Listing on a foreign stock exchange is also an ideal for many Chinese CEOs, says Edith Yeung, head of marketing for Dolphin Browser, a mobile browser, and an angel investor.
Yeung says many Chinese entrepreneurs view Yahoo co-founder Jerry Yang as a role model. "An American listing not only stands for freedom, it is the dream come true," Yeung says. Another problem for foreign investors that list in China is that shares are enumerated in Chinese currency. "You cannot (easily) change yuan to dollars," Lin says.
Lin says DCM's strategy is to list in China conventional manufacturers or makers of plastic products that have strong domestic markets. In March 2011, the firm took Shanghai Luxin Evotech, a maker of specialty wrapping paper, to the Shenzhen exchange (SZSE:002565). By contrast, DCM listed Vipshop, an online retailer of discounted brand-name products, on the New York Stock Exchange.
Gillis believes the attraction of listing in the domestic market will increase as Chinese capital markets mature. "I think the mainland market is the natural place for Chinese companies to list," Gillis says. "The only limitation has been the capacity of the Chinese market to absorb the number of companies that need to list."
(Read more: Year winds down, HK IPOs just ramping up)
But with the world's second-largest economy growing at a 7 percent annual rate and more than 700 million Internet users, the amount of money available to start-ups can only increase.
—By Joel Dreyfuss, Special to CNBC.com.