Greenberg: Chinese IPO Bubble Brewing in U.S.?

There’s no stopping Chinese IPOs.

Twenty-four of them this year—double last year, according to Renaissance Capital.

Great Wall of China photo composite
Great Wall of China

And investors love them: Bidding them up on average by 13 percent on the first day of trading.

Why care?

Because as was the case with Chinese reverse mergers, which I’ve written about in the past, you may own them.

Taking a look at the most recent roster Chinese IPO owners is like a who’s who of big investors, including mutual funds, ETFs and pension funds, including Fidelity , Federated Investors , Massachusetts Financial, Royce & Associates and Blackrock’s small-cap ETF.

Even CalPers, the big California pension fund, has gotten into the act (via China Electric Motor, which has $90 million in revenue but is profitable.)

China Electric is more the rule than the exception. Most of things these companies, regardless of whether they’re making money, are dinky. If they have $100 million in revenue—they're big.

Le Gaga, a vegetable greenhouse operator in China, priced at the high end of its range today even though it has only $41 million dollars in revenue.

But anything drives you nuts, it’ll be its accounting. Consider the way Le Gaga values its inventories. From its IPO prospectus:

“Adjusted cost of inventories sold is defined as cost of inventories sold before biological assets fair value adjustment. We are primarily engaged in agricultural activities of cultivating, processing and distributing vegetables and have therefore adopted International Accounting Standard 41 “Agriculture,” or IAS 41, in accounting for biological assets and agricultural produce. Unlike the historical cost accounting model, IAS 41 requires us to recognize in our income statements the gain or loss arising from the change in fair value less costs to sell of biological assets and agricultural produce for each reporting period."

It continues, "Cost of inventories sold determined under IAS 41 reflects the deemed cost of agricultural produce, which is based on their fair value (less costs to sell) at the point of harvest. Biological assets fair value adjustment is the difference between the deemed cost of the agricultural produce and the plantation expenditure we incurred to cultivate the produce to the point of harvest. Although an “adjusted” cost of inventories sold excluding these fair value adjustments is a non-IFRS measure, we believe that separate analysis of the cost of inventories sold excluding these fair value adjustments adds clarity to the constituent parts of our cost of inventories sold and provides additional useful information for investors to assess our cost structure. Set forth below is a reconciliation of adjusted cost of inventories sold to the most directly comparable IFRS measure, cost of inventories sold.”

My interpretation: Keep your fingers crossed and get out the white board!

And there are the risks, with the No. 1 risk factor: “We primarily rely on arrangements with farmer households, local villagers’ committees or local governments to lease farmland or forestland."

My concern: Who is going to enforce those “arrangements”?

And this note: As Chinese IPOs accelerate, Chinese reverse mergers in the U.S.—a backdoor way to go public here—slowed by 30 percent in the third quarter, though still up from a year ago, according to The Reverse Merger Report. Editor Brett Goetschious says some of the slowdown may be the result of accounting-related concerns.

My take: Some reverse merger candidates may also be going the IPO route as blue chip underwriters, eager for easy fees, do what they do with every hot fad: Take the good, bad and ugly. While some are likely to be winners, this explosion in China IPOs has a familiar feel -- and it's not a good one.