China Economy

Chinese companies still hope for New York IPOs — despite recent fraud, scandals and coronavirus

Key Points
  • Luckin Coffee and TAL Education have each in the last two weeks disclosed fraud within their companies.
  • But some in the cross-border listing business say Chinese companies are still intent on listing in New York, despite postponements caused by the coronavirus or geopolitical tensions.
  • In the near term, annual audits delayed by the coronavirus mean more corporate issues may come to light soon, said Drew Bernstein, co-chairman of MarcumBP, which audits and advises pre-IPO and public Chinese companies.
Xueling Li, chairman of Huya Inc., center left, rings a ceremonial bell with Rongjie Dong, chief executive officer of Huya Inc., center right, during the company's initial public offering on the floor of the New York Stock Exchange, May 11, 2018.
Michael Nagle | Bloomberg | Getty Images

For many Chinese companies, their dreams of listing in New York are only on hold.

Some high-profile Chinese stocks listed in the U.S. such as Luckin Coffee, the self-proclaimed Starbucks rival in China, have been rocked following allegations by short-sellers that these companies faked their numbers, accusations that in some cases are now being internally investigated.

The reports are the latest challenge for Chinese initial public offerings in New York, on top of U.S.-China trade tensions and the impact of the coronavirus

But some in the cross-border IPO business say the listing plans are just delayed, not canceled.

"I do know Chinese companies that are planning to list this summer as soon as after Labor Day," said Jim Fields, a Shenzhen-based producer of videos for Chinese companies presenting to potential IPO investors in the U.S. China celebrates the holiday on May 1.

Fields noted the new IPO timeframe is a delay of about one to three months.

Last year, 25 Chinese issuers went public in the U.S., in addition to three special-purpose acquisition companies — companies that raise money to buy another — according to Renaissance Capital, which sells IPO-focused exchange-traded funds. That's down from 32 Chinese listings in 2018, which was double that of the prior year and the most since 2010.

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Officially called Covid-19, the coronavirus disease first emerged in the Chinese city of Wuhan in late December and has since spread worldwide in a global pandemic that's killed well over 125,000 people. Governments have shut down much business activity, leading to growing expectations of a recession that have rocked financial markets. Meanwhile, China and the U.S. have been trying to make some progress on a phase one trade agreement signed in January after more than 18 months of tensions.

Despite geopolitical and epidemiological challenges in the first three months of this year, seven Chinese companies and three special-purpose acquisition companies went public in the U.S., according to Matthew Kennedy, IPO market strategist at Renaissance Capital. 

"We suspect several more had planned to list, but delayed their offerings amid the Covid-19 outbreak," Kennedy said in an email. "As we noted in our 1Q20 Review, China appears to be the first country emerging from the pandemic, so Chinese companies may also be first to return to the IPO market. However, these financial scandals do reputational damage to Chinese issuers broadly."

On April 2, Luckin Coffee announced an internal investigation found the chief operating officer fabricated sales by about 2.2 billion yuan ($314 million) from the second to fourth quarter of last year. Shares have plunged more than 80% since the latest disclosure this month, and have been halted for pending news for roughly the last week.

About two months ago, investment firm Muddy Waters said it was shorting, or betting on a decline in the price of the stock, based on an anonymous report that alleged the coffee company fabricated financial and operating numbers beginning in the third quarter of last year. Luckin said at the time the allegations were "misleading and false."

The company did not respond to a request for comment. Representatives from Nasdaq and the New York Stock Exchange were not available for interviews for this story.

Other high-profile U.S.-listed stocks have come under scrutiny in the last several days.

Shares of video streaming site iQiyi, which is majority-owned by search giant Baidu, dipped last week after a report by Wolfpack Research alleged the video company inflated revenue by about $1 billion to $2 billion. Muddy Waters said it assisted Wolfpack with the report and is also betting against iQiyi's stock. The Chinese company said in a statement it believed the report contained "errors" and was "misleading."

Tutoring company TAL Education announced last week it suspected an employee of inflating sales for its "Light Class" product, which accounts for about 3% or 4% of the company's total estimated revenues. TAL said the employee has been taken into custody by the local police.

More to come

"We are in the height of the year-end audit season,“ Drew Bernstein, co-chairman of MarcumBP, which audits and advises pre-IPO and public Chinese companies, said in an email Thursday. “Due to COVID-19, a lot of the fieldwork was delayed, so critical audit issues are just now starting to be discussed at the senior level."

Bernstein noted Chinese issuers were already under close scrutiny before the Luckin disclosure, and he expects auditors will be tougher, likely revealing more cases of financial fraud.

In the near-term, we may see some Chinese companies favor Hong Kong as a listing venue. But for many CEOs, the U.S. remains the most desirable place to IPO and access growth capital.
Drew Bernstein
co-chairman of MarcumBP

"We are telling our clients to be prepared for more scrutiny and higher standards," he said. 

The challenge for Chinese companies is they tend to operate in a market that is fundamentally different from that of where the exchanges are based. Gaps in information can sometimes make it harder for overseas investors to assess differences between highly innovative companies and those fudging their numbers.

For example, Luckin's debut on the Nasdaq in May 2019 came a rare 18 months after the company's launch. The company caught Wall Street's eye with its aim to outpace Starbucks with the number of locations in China by using a strategy that relied on small storefronts and tapping the domestic mobile-delivery trend.

"Short-(biased) activist research funds will continue to go after Chinese companies and find as much (dirt) as possible," said Edith Yeung, partner at early stage investor 500 Startups. "My general rule ... has always been invest in things you understand."

She remains optimistic on China, especially since she expects many start-up CEOs who experienced the outbreak of SARs roughly 17 years ago understand what kinds of industries will thrive or not amid a health crisis.

Political pressure persists 

The reports come as Chinese investment in the U.S. has faced increased scrutiny under President Donald Trump's administration. Pressure from the White House has contributed to a slowdown in what was once a rush of Chinese acquisitions of U.S. companies. In September, the administration was considering curbs on U.S. investments in China, as well as investments in Chinese companies listed in the United States, according to sources. 

At the time, Qiming Venture Partners managing partner Nisa Leung said the news gave her some second thoughts about investing in the U.S. The firm still has about 20 companies looking to file for a listing in Hong Kong, mainland China or the U.S. in roughly the next 20 months, Leung said. The majority of the businesses are in health care, she said.

The coronavirus outbreak hasn't swayed Qiming's ability to raise capital, either. On Thursday, the Chinese firm said it closed an oversubscribed $1.1 billion Fund VII, after beginning the fundraising in San Francisco in February. 

For the near future, Leung said, the firm is eyeing Hong Kong and mainland China for IPOs. "Some companies may still choose the U.S.," she said. "It's hard to tell."

Eyes on alternative sites

Uncertainty about U.S. politics could drive more interest in markets such as Hong Kong, or even London. Hong Kong has sought to boost its attractiveness as a listing market by making it easier for biotechnology companies with no revenues or profits to apply to go public there. The Chinese government would also like to keep its giant technology companies closer to home. Alibaba held a secondary offering in Hong Kong last year, five years after its initial public offering on the New York Stock Exchange.

"In the near-term, we may see some Chinese companies favor Hong Kong as a listing venue,” Bernstein said. "But for many CEOs, the U.S. remains the most desirable place to IPO and access growth capital."

Chinese IPOs in the U.S. dropped off sharply following the Sino-Forest scandal in 2011, falling from 40 the year prior to 3 in 2012, according to Renaissance Capital. Muddy Waters alleged the Toronto-listed Chinese timber company was a worthless ponzi scheme, and the company ultimately collapsed.

"If management wants to defraud you, they will and they can, and it can probably be detected," said Dan McClory, head of China and equity capital markets at Boustead Securities, which works with small-cap Chinese companies looking to go public overseas.But he said many companies never even make it past initial due diligence given their unwillingness to resolve issues found in tax records and executive background checks.

McClory added that some Chinese companies have recently showed more interest in listing in London, where Boustead also operates. Still, "to the credit of the Nasdaq and NYSE, it is the aspiration of every Chinese entrepreneur to list on the Nasdaq and NYSE," he said. "So it's really difficult to change that goal."

A few years after the Sino-Forest scandal knocked Chinese IPOs in the U.S., Renaissance Capital's Kennedy pointed out that the listings came back stronger than ever, notably with Alibaba's share sale in 2014 where the technology company raised more than $20 billion in what was then the world's largest IPO.

— CNBC's Arjun Kharpal contributed to this report.