Last exit for Brooklyn?

Policy risk has always been a concern for Wall Street investors in Chinese firms – dating back to when minivan maker Brilliance China was the first from the country to launch an IPO on the New York Stock Exchange (NYSE) in October 1992.

The flood of IPOs from Chinese debutants in more recent years seemed to signal that risk appetites for Chinese stocks have grown stouter, especially for companies from the internet sector.

Yet perhaps a few fund managers had unwisely forgotten how a change in government thinking can soon dim a growth story, which is exactly what happened this month to Didi, China’s ride-hailing giant.

With Didi’s bankers rushing through a roadshow in just a few days, IPO investors were counting on another lucrative payday when one of the world’s oldest and most valuable unicorns went public on the NYSE in late June.

But it wasn’t to be: instead infuriated Chinese regulators suddenly stopped Didi from registering new customers just days after the ride-hailing platform’s debut (see WiC548). Didi’s shares plunged as the investment world was reawakened to the risks of a change in attitude from the Chinese government.

The Didi debacle has had an immediate impact on other Chinese firms waiting to IPO in New York, some of which have dropped or delayed their own plans to sell shares. Indeed, the ongoing situation raises questions for some of the fastest-growing companies in China. Specifically what does it mean for the valuations of China’s burgeoning crop of unicorn firms and their private equity backers?

What’s the latest on Didi?

When we published our inaugural ranking of China’s Top 50 Unicorns earlier this year, Didi was the third largest on our list, valued at $62 billion. The nine year-old firm has now exited our ranking, thanks to its NYSE flotation (by definition a unicorn must be unlisted). Its market value briefly challenged the $90 billion mark during the first day of trading. But it has been on a downslope since then, dropping beneath $60 billion this week – lower than when it was a privately-held ‘unicorn’ company.

Didi has been caught up in a crisis of investor relations and government relations since its inaugural day as a public company. Its task now looks Herculean in shouldering the pressure from both Wall Street and Beijing – and risks appeasing neither party.

According to a report this week in the Wall Street Journal, “a disconnect developed” in the final days before Didi’s NYSE debut. Regulators in China were under the impression that Didi would put the brakes on its IPO while it addressed their concerns on data security. But the newspaper claims that Didi had also assured sponsors and investors in New York that it had been given Beijing’s blessing for its American public offering.

In the ensuing mess Didi now faces regulatory action at home and across the Pacific, including class action lawsuits from disgruntled US investors who feel misled.

How is this impacting other Chinese firms with plans to IPO in the US?

The crisis has worsened over the last week, especially on China’s domestic front as various regulatory bodies look more closely at the listing candidates heading for New York.

Didi is still in the eye of the storm, warning investors on Monday of further “adverse impacts” after the Cyberspace Administration of China (CAC) ordered the removal of 25 more of its apps for further violations of “data security”. The newly banned booking tools include the corporate version of its core ride-hailing service, as well as those covering carpooling, finance and food delivery.

The argument from the CAC is that the risks of these platforms disclosing sensitive data to foreign entities have not been properly addressed. It also announced last Saturday that it would be undertaking a broader review – beyond Didi – of risks for data that could be “affected, controlled, and maliciously exploited by foreign governments” and that any company holding data on more than a million users would have to undergo a security review before selling any of its shares offshore (see this week’s “Banking and Finance”), i.e. in the US.

Many companies – including Brilliance China in 1992 – have used a so-called ‘variable interest entity’ (VIE) structure to go public in New York. These arrangements have always constituted something of a legal grey area (see WiC268) but have still been deployed by hundreds of Chinese tech firms (including behemoths like Alibaba). Yet Bloomberg reported last week that senior regulators in Beijing are now looking at closing this loophole and banning Chinese firms with active businesses in the country from conducting further overseas floats via VIEs (such a restriction would have blocked the recent Didi IPO).

The pushback from the government side comes after a dramatic pickup in IPO traffic heading to the US (see WiC545 for an explainer on what has been driving that trend). A New York listing offers an alluring exit opportunity for the private equity investors behind China’s unicorn herd. So the Didi case is crystallising concerns that the route out of these investments is starting to narrow. Reportedly the fitness app Keep and the podcasting platform Ximalaya – both of which feature in our top 50 ranking – have shelved their preparations for New York IPOs in the last few days. Both have more than 200 million users, which means they would now need regulatory approvals from China to push ahead. Clearly, they weren’t confident about getting the green light and as many as 70 other private firms based in Hong Kong and China that were set to go public in New York are reviewing the situation, Bloomberg claimed this week.

Even Bytedance – the biggest unicorn of all – seems to have the same concerns: it put plans to sell shares offshore “indefinitely” on hold this week, according to media reports.

Has the change in mood affected our unicorn rankings?

We launched our Top 50 Chinese Unicorns list in the first quarter – with a dedicated website (www.weekinchina.com/unicorns/). We are updating it on a quarterly basis, removing the companies that make it to the public markets and adding candidates that have raised new venture capital that has seen their valuations surge beyond $1 billion (the minimum a firm must be worth to count as a unicorn).

We expected to see some of the unicorns move up the ranking based on new funding rounds from pre-IPO investors that have scaled up their bets. But the changes in the ranking have turned out to be more dramatic than we anticipated, and not only because of Didi’s explosive exit from the top three.

Perhaps the most notable movement in our updated listing is that Ant Group has lost its top spot to Bytedance. At one point in its epic fundraising journey, the fintech arm of the Alibaba Group was valued by private equity backers at more than $300 billion. But the spectacular blow-up of Ant’s dual listing in Shanghai and Hong Kong last October, as well as a newly-ordered realignment of its business model from a group of government agencies (see WiC536), has upended its prospects, incinerating at least $100 billion from its valuation.

Conversely, the financial fortunes of internet giant Bytedance – the operator of TikTok – have risen swiftly in the post-Trump era. A new trading platform established by the Nasdaq-listed website 36Kr saw three tranches of Bytedance’s unlisted shares put up for sale last month at a price that valued the firm at nearly $400 billion. After a banner year in 2020, Bytedance’s ballooning value reflects its status as one of the few Chinese tech firms to find real success outside China, Nikkei Asia noted.

CNBC reported last month that revenues more than doubled to $34.3 billion last year, according to a company insider. Gross profit at Bytedance rose 93% to $19 billion, the business news channel claimed, citing coverage of the company in the US media.

Our list’s edtech unicorns have been under more pressure?

Besides the leading internet platforms like Didi and Ant, providers of online education and after-school tutoring services (known as ‘edtechs’) have also suffered from sudden changes in government policy. Two of the biggest edtech unicorns, Zuoyebang and Yuanfudao (backed by Alibaba and Tencent respectively) were both fined by the State Administration for Market Regulation (SAMR) in May for inaccurate marketing, including misleading parents about the qualifications of their teaching staff.

Last month Beijing’s antitrust watchdog was in action (yet again), dishing out Rmb36.5 million ($5.64 million) in fines for similar offences to 15 private education providers, including US-listed New Oriental and TAL Education.

The edtech sector had enjoyed breakneck growth during the Covid-19 lockdowns last year, which were a catalyst in moving more study online. Financial data aggregator 100Ec.cn has reported that VC fundraising for Chinese edtech firms surged 267% to Rmb53.9 billion last year, more than the fundraising for the sector in the previous four years combined.

The government’s tougher line on edtech (see WiC546) is part of a wider effort to curb the influence of the largest internet platforms. But there are sector-specific factors as well. Spending on online tutoring is fuelled by parents anxious about the career prospects of their children. These concerns have added to the financial pressures on families, dissuading many parents from having more children, despite promises from the government of new incentives to accompany the newly introduced Three-Child Policy (see WiC543).

The internet sector’s so-called ‘996 culture’, i.e. working from 9am to 9pm, six days a week, has also been blamed for keeping parents away from home and increasing the demand for after-school tutoring. Some tech firms are starting to cut back on these longer working hours, in recognition of government concerns. In a bold first strike, a video game developer owned by Tencent has launched a “happy work, healthy life” regimen, for instance, promising to give staff a better work-life balance (see WiC547).

This change in mood – and government policy direction – has taken some of the steam out of the edtech sector. TAL Education’s market value has dipped 65% over the last six months, for example, to about $14 billion as of this week. And even before the Didi IPO darkened the outlook for China’s unicorns in general there had been a barrage of negative media questioning the prospects of the edtech platforms. On the back of that two unicorns in our ranking – Yuanfudao and VIPKid – had already shelved their New York listing plans.

So which firms are the new entrants in our unicorn ranking?

Coming in at position 11 is Moviebook, a technology company with expertise in ‘intelligent video production’. It deploys deep learning in the structuring and delivery of online video, a growth area in the context of China’s ‘streaming’ boom. Its main investors include the prominent AI firm SenseTime (another of the unicorns in the Top 50). Moviebook’s valuation is said to have reached $15 billion after a fundraising in February from New Oriental Education and the Cultural Industry Fund.

In final position in our list Kuaikan Manhua is the leading online marketplace for e-comic books. It offers licenced content but also allows its users to create and submit their own materials. Traditionally the most popular comic books in China have come from Japan but Kuaikan Manhua has been making the case that the Chinese should be more active in this market themselves. The hope is that creative activity on the platform will bring commercial success, perhaps by spawning China’s answer to a franchise like Marvel. Combinations of original material with new avenues in merchandising and licencing underpin a current valuation of about $2 billion.

Two other entrants are Mixue Bingcheng, a chain of tea and ice cream stores, and Yuanqi Senlin, a producer of sugar-free and low-calorie beverages (see WiC511; it goes by the brand name of Genki Forest in English). The duo’s combined value is less than $10 billion but their stellar rise could have American giants Starbucks and Coca-Cola watching with interest. Some of their growth comes from changing appetites among more health-conscious consumers.

Meanwhile local private equity investors like Sequoia China and Hillhouse Capital have also been betting on homegrown consumer brands being able to scale up into national icons. One example is HEYTEA: its valuation grew in our quarterly update from $2 billion to $9.5 billion – among the largest jumps in percentage terms among the unicorns we tracked this year (it ranks 16th on our list). The increase was partly fuelled by the achievements of its seven year-old rival Nayuki, which was valued at $3.5 billion in the public markets following its listing in Hong Kong last month.

E-commerce and logistics are two of the other major themes for our Chinese unicorn herd. One of the business models that combines the two is ‘community group buying’, which has become a new focus for many of the internet majors (we first focused on the phenomenon in WiC521). The service essentially allows groups of residents in the same neighbourhoods to get discounts by shopping together in bulk and using a central pickup point.

Most of the new group-buying platforms make their sales via apps or other internet platforms. Qiandama – valued at Rmb25 billion, and another of the seven newcomers on our list – is a fast-growing firm that has bucked the group-buying trend. With almost 3,000 outlets nationwide – a third of which have opened in the past 12 months – Qiandama is a fresh food store that has stuck with more of a bricks-and-mortar focus. Its zero-inventory model carries the tagline of “never selling overnight meat” and has proved popular with middle-aged female shoppers (known as ‘dama’ hence the company’s name; the first part ‘Qian’ is a popular surname associated with the word ‘money’).

WiC first wrote about Qiandama in May (see issue 540), mentioning its opening of stores in Hong Kong. Bloomberg reported at the time that this may have been partly motivated by its plans for a $500 million IPO on the city’s bourse.

So are the exit windows getting narrower for investors?

Talk of a Hong Kong share sale for Qiandama raises questions for how it, and other unicorns may plan to bring in new investment from the public markets. Yet the next update for our Top 50 Unicorns could well see less turnover in the rankings than the current one. That’s because it’s unlikely that many of them will push ahead in the coming months with New York IPOs – previously a favourite way of going public.

Of course, IPOs will not go away: a recurring mantra in the state media is that the Chinese government is cultivating an environment that helps the country to stay competitive in technology and innovation. The capital markets are still crucial in achieving that goal, not least in incentivising entrepreneurs to create new companies and experiment with new business models. So even if listings on Wall Street are going to dry up for the remainder of 2021, there will have to be a focus on other exit options.

The most obvious channels are IPOs in Shenzhen or Shanghai (on its STAR Market) or possibly most likely of all in Hong Kong. Stock market investors have been buying into this trend too. The share price of HKEx, the operator of the Hong Kong bourse, rose 5% the day after Didi was hit with its post-IPO regulatory backlash. That was a sign that the smart money thinks that unicorn IPOs formerly destined for the US financial capital are now more likely to flow to Hong Kong as the preferred alternative…

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