China’s plan to create a new board for strategic emerging industries on the Shanghai Stock Exchange has been called into question after it was deleted from the country’s 13th Five-Year Plan, the roadmap that sets the course for the Chinese economy in the next five years. No formal announcement has yet been made by Chinese government regarding this obvious change, but it has stirred speculation that the plan might be scrapped entirely.
The strategic emerging industries board was the target for many overseas-listed Chinese companies that planned on returning to the Chinese domestic stock market. Significant ones include cyber security company Qihoo 360 and mobile-based social networking platform Momo. If the new board is cancelled, these companies will have to seek other more challenging and risky paths to relisting.
The strategic emerging industries board
First things first: what exactly is the strategic emerging industries board?
It is a stock exchange designed to make it easier for fast-growing innovative enterprises, like Alibaba’s Ant Financial, to raise funds from the capital market.
According to a previous official announcement, the purpose of setting up the new board was to boost China’s “strategic emerging industries” such as computer science, information technology, renewable energy and bioscience. It was considered an important move to aid in the transformation of China’s economy towards slower but more sustainable growth driven by innovation and technology breakthroughs.
The plan was put forward by the Shanghai Stock Exchange last June. It has been regarded as Shanghai’s attempt to challenge its domestic rival, the Shenzhen Stock Exchange, which soared 126% in 2015. The Shenzhen Stock Exchange successfully attracted technology and innovation-driven companies to list on its Nasdaq-style startup and growth enterprise board, known as ChiNext.
How is the strategic emerging industries board different from other boards in China?
Currently, China has several trading markets including the Shanghai and Shenzhen Main Boards, ChiNext, the SME Board and also the New Third Board. The country has developed a relatively complex multi-tier capital market.
According to the state-run Xinhua News Agency, the strategic emerging industries board will cater to companies like Xiaomi, with short business records but strong profitability, or e-commerce platform JD.com, with weak profitability but innovative business models. It can also be used by companies that have no profit record but have a large amount of assets and promising prospects, such as the Commercial Aircraft Corporation of China.
As the Shanghai Stock Exchange deputy manager Liu Shi’an said at a financial forum, the new board would have greater inclusiveness, mainly focusing on enterprises’ future profitability rather than current profitability.
Problems might arise for overseas-listed Chinese companies seeking to list at home
Considering the conditions mentioned above, quite a few Chinese companies consider themselves “undervalued” in the U.S. markets. These are the companies seeking to to be relisted on the new board.
More than 30 Chinese technology, media and telecom companies were trying to delist from foreign boards and relist in China, just like Qihoo 360 and Momo. They have been expecting the new board to be an important funding channel and listing destination.
But if the plan for the new board is abandoned, it will become tricky for these companies and they will have to seek other solutions.
There are three complicated steps involved in delisting from overseas boards and relisting at home for Chinese companies. The first step involves going private and delisting; the second is the dismantling of the so-called variable interest entity (VIE) ownership structure; and the third is relisting back home.
Each step is full of uncertainties considering the huge costs and various legal provisions involved. Once an overseas-listed company kicks off its campaign for relisting on the mainland, the costs to reverse its decision are tremendous.
Meanwhile, the requirements for listing on China’s main boards are highly demanding. To list on the Shanghai or Shenzhen Stock Exchanges’ main boards a company must: 1) be profitable in the last three consecutive years with aggregate net profits no less than RMB 30 million and in continued growth and 2) have an aggregate operating income over the last three financial years over RMB 50 million or, 3) have an aggregate operating income over the last three financial years over RMB 300 million.
According to Caixin media, even if a company meets all these requirements, it has to line up behind 600 other companies waiting for the examination and approval from the China Securities Regulatory Commission. The process can last for months, and sometimes even be temporarily suspended if there are major fluctuations in the Chinese stock market. It presents a high risk to companies that privatize off U.S. stock markets by attaining great amounts of money in private equity.
This is the reason that Qihoo 360 and Momo have high expectations for Shanghai’s new board. But now they may be disappointed.
What’s the next step on their way back?
Generally, launching an IPO on the main boards, choosing a backdoor listing and listing on the New Third Board are the three ways Chinese companies get listed.
The New Third Board is a national over-the-counter stock exchange, allowing micro, small and medium-sized enterprises with investable funds of no less than RMB five million into the capital markets. Obviously, it has a lower threshold than China’s other boards.
However, the New Third Board has a higher bar for investors: individual investors must have assets of more than RMB five million. This barrier to entry limits the number of investors on the board as well as the market liquidity, which makes it a less suitable choice for large companies like Qihoo 360 and Momo that have huge market valuation.
It looks like backdoor listings may be the preferable road for now.
A backdoor listing, or a reverse merger, means a private company acquires a publicly-traded company so as to be listed on the stock market.
In 2015, six overseas listed companies, including budget hotel chain Home Inn, tutoring services provider Xueda Education Group and real estate Internet portal Sofun, successfully achieved a backdoor listing.
A backdoor listing is a low-cost option featuring a relatively simple procedure for examination and approval. The high potential return and larger chance of success compared to other options make it the favorable road to take at the moment.
Considering the possible abolishment of the strategic emerging industries board, a backdoor listing may be the best choice for Qihoo 360 and Momo to achieve a listing in a Chinese stock exchange in a relatively short time.
（Top photo from taopic.com）