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China firms head for US IPOs, not fussed by accounting flap

Monday, 10 Feb 2014 | 6:35 PM ET

Chinese companies are flocking to the U.S. IPO market in their biggest numbers since 2010, drawn by soaring valuations for tech start-ups and undeterred by a flare-up in an accounting row between Washington and Beijing.

Some 30 Chinese companies could list in the United States this year, according to investment bankers interviewed by Reuters. That includes JD.com, China's second-biggest e-commerce firm after Alibaba Group. It said last month it is seeking to raise $1.5 billion, in what may be the second-biggest U.S. IPO by a Chinese company.

(Read more: First wave of Chinese IPOs gets underway)

The return to U.S. shores comes on the back of renewed investor enthusiasm for China plays, particularly for Internet stocks. The country's online retail market by transaction volume jumped 42 percent last year to 1.85 trillion yuan ($305 billion) and is expected to almost double in size by 2016, according to figures from iResearch.

That has trumped lingering concerns about accounting irregularities and corporate governance issues that have forced many U.S.-listed Chinese firms to be delisted since 2011.

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The delistings have prompted investors to be more discerning about China IPO candidates this time around. The bar for Chinese companies seeking U.S. deals is higher, improving the quality of recent offerings, bankers say.

But not everyone is so certain about that.

John Hempton, chief investment officer of Sydney-based Bronte Capital, said a lack of penalties for Chinese firms' past misdeeds in the 2011 scandals meant the potential to find accounting fraud was always there.

(Read more: Watchout, Alibaba—your rival just filed for US IPO)

"We welcome the new bull market," said Hempton, best known for having taken short positions on several U.S.-listed Chinese companies in the past. "We hope that they issue hundreds of new shares because they will provide our future happy hunting ground."

And bull market it is. While only eight Chinese companies listed in the United States last year, raising a combined $1.1 billion, the returns have been spectacular.

Semiconductor solution provider Montage Technology Group and 58.com, billed as China's Craigslist, have jumped at least 70 percent since their debuts. Online sports-lottery operator 500.com has nearly tripled in value since listing in late November.

Newly U.S.-listed Chinese firms rocketed an average 53 percent on their debuts last year, according to consulting firm EY. The technology-heavy Nasdaq Composite Index rallied 28 percent over the past year.

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"The last companies that went public, proved to the street that there's a lot of growth still here," said David Chao, co-founder at venture capital firm DCM, which is based in Silicon Valley and has invested in several U.S.-listed Chinese companies.

Regulatory Row

The 2011 scandals sparked much tension between regulators of both countries regarding the oversight of auditors and access to company information that has continued ever since.

Indeed, JD.com's announcement came less than two weeks after a U.S. Securities and Exchange Commission (SEC) judge recommended banning Chinese units of the Big Four accounting firms from auditing U.S.-listed companies.

But the two sides could be close to a deal that would allow Washington to inspect the audit work of accounting firms in China, a U.S. audit watchdog said last week, which could go a long away to alleviating strains.

Paul Botlz, partner at law firm Ropes & Gray said Chinese companies should not be put off by the apparent escalation of the standoff due to the SEC move.

(Read more: The man behind Alibaba's eventual IPO)

"I think this is a bit of a blip. I would advise companies: don't be too spooked, if you want to go to U.S. markets don't let this stop you, just check with the auditors on what's their back-up plan," he said.

For Chinese companies, the U.S. market affords them options not available in Hong Kong, such as dual-class structures and the ability to list without having turned a profit. It also offers far more liquidity than the newly reopened mainland China IPO market.

This year, in addition to JD.com and a $300 million offering from a security software unit of Kingsoft, IPO candidates include real estate website Anjuke.com, gaming company Chukong Technologies and online cosmetics company Jumei.com, bankers said.

Anjuke did not reply to an e-mail seeking comment. Representatives for Chukong were not available for comment and Jumei.com could not be reached for a comment.

Companies that are likely to benefit from the boom in China consumer spending will be in greater demand than software makers facing potential piracy or companies in the heavily-regulated financial services sector, Chao at DCM said.

(Read more: US biotech IPOs start 2014 at record pace)

Most of the China firms that list in the United States use a structure known as variable interest entities (VIEs). This vehicle gets around Chinese rules against foreign ownership in sectors such as online retail and e-commerce. A VIE will give investors access to a company's profits but not give them any ownership of the company.

"As people see value in the stocks and deals started to perform, returns could potentially offset the additional risk, like VIE, that people take when they invest in China," said Joaquin Rodriguez Torres, head of technology, media and telecom investment banking in Asia at Deutsche Bank, which worked on the IPOs of 500.com and travel services company Qunar Cayman Islands last year.

More than 140 Chinese companies have raised $36.6 billion through U.S. IPOs since 2000, Thomson Reuters data shows, with the peak in 2007 when they raised a record $6.9 billion.

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