Dark days ahead?

Out of gas: China Auto Rental cancelled its New York IPO

For an industry primed to talk up its own prospects, the bankers’ response to China Auto Rental’s recently failed New York IPO was a deflating one.

The underwriters were unable to raise even half of the IPO’s targeted $138 million, and were especially shocked when investors told them not to bother even pitching their case for China’s biggest provider of car rental services.

“It’s the worst response for a US listing I have seen in my entire career,” a banker close to the deal told International Financing Review. “We knew from the start US investors had a negative view on China listings but it turns out that the situation is much more negative than we had thought.”

A bigger trend is at work, mind you, with a rapid decline in the number of Chinese companies listing overseas from a peak of 110 in 2010 down to just 10 so far this year (as of the middle of April).

In New York itself only one Chinese firm has debuted in 2012. Vipshop, an online discount store, raised less than half of the capital it had targeted and is now trading well below its issue price.

The world seems to have lost its appetite for Chinese stocks. Why?

One answer is the new pessimism on Chinese growth. The argument is that as China’s economy slows, so do the prospects of many of its companies. But sentiment towards overseas Chinese stocks also seems to have soured much more sharply than concerns about the wider economy would merit. After all, there is still a general consensus that a hard landing is being avoided, even if growth is slowing.

Instead international investors seem to be shunning Chinese companies because of their track records. It has been a rude awakening. If you look back at the firms that listed overseas two years ago – the record year for Chinese IPOs – their stock price performance has been appalling compared to the market average. Here are two examples, drawing on Bloomberg data. The 56 Chinese firms to debut in Hong Kong in 2010 are now down 27% on their IPO prices (the index dropped 3% on its average two years ago). And in New York it’s even worse: the 40 Chinese stocks have dropped 39%, compared to a 22% rise for the S&P500 over the same period.

Of course, there has also been a cascade of negative news, beginning with a series of attacks from short-sellers last year. Highest profile was Muddy Waters’ assault on Sino-Forest, a timber firm listed on the Toronto board (see WiC111), which led the forestry company to file for bankruptcy protection in March.

In fact, trees seems to be a troublesome area. Last month another logging company, Hong Kong-listed China Forestry Holdings, admitted that it is unable to account for 99% of Rmb2.4 billion of the sales that it has claimed previously.

Other similar cases, a string of auditor resignations, and number of company delistings have also stung regulators into action. For example, the Securities and Exchange Commission in the US put out a warning last year on firms that may be prone to “fraud and other abuses” (see WiC108 for our first mention of the problem in May last year). And it remains a topical issue. Hong Kong’s Financial Reporting Council, a statutory body charged with investigating audit and reporting irregularities, announced last month that it was investigating a further 13 Chinese companies, although it refused to name them.

With that kind of backdrop, it is little surprise that Chinese concept stocks have lost their lustre overseas, says the National Business Daily. But there isn’t much sympathy on offer in China’s press for foreign investors. As Economic Reference News points out, they seemed happy enough with the risks at the time. That’s in spite of the fact that many of the Chinese stocks in question were early-stage internet firms lacking scale, who hadn’t offered rigorous financial information, and who (in some cases) had been turned down for listings in China itself. Even Vipshop, the only Chinese firm that did manage an IPO in the US this year, conforms to this stereotype, Economic Reference News suggests. “Their problem is not how to develop and expand, but how to survive,” it warned last week.

By contrast, International Financing Review is more forgiving in its analysis of China Auto Rental, the most recent candidate shunned by US investors. IFR says China Auto would have been a prime candidate for IPO in the past – it’s by far the biggest firm in its sector, the first of its kind to seek a listing in the US, and backed by a credible shareholder in Legend Capital, a subsidiary of Lenovo’s parent.

In the meantime the pressing question is whether sentiment is about to worsen, as we enter what a number of commentators have been calling “fraud season”. Deadlines are looming for overseas-listed Chinese firms to report their financials, and the bet is that many will request additional time or simply “go dark” by refusing to file information or communicate with regulators.

In these circumstances, expect the investor mood to darken too.

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