U.S. China Commission Hearing
April 16, 2004
written_testimonies of Amit Tandon
Managing Director
New York Global Securities, Inc.
It is an honor and privilege to provide written_testimonies to the Commission regarding the presence of Chinese companies’ listings on the U.S. and international capital markets. Chinese companies have experienced relative success in the U.S. capital markets, and this is a trend that is projected to continue and intensify in the future. My written_testimonies today will focus on the small and medium-sized enterprises in China (SMEs) and the financing options available to such enterprises. My remarks will refer to the relative advantages and disadvantages of listings on certain regional stock markets such as Hong Kong and Singapore as well as listings on the U.S. capital markets.
The World Bank has referred to the private sector in China as the most dynamic component of the Chinese economy, and for good reason, since this sector contributes approximately 60% of the gross domestic product of the country, according to a Beijing-based think tank. China managed to attract $57 billion in foreign direct investment in 2003, despite SARS and a general downturn in the global economy. Furthermore, according to a recent article, contracted FDI surged to $115 billion, an increase of 39% from the previous year. SMEs are broadly defined to include private enterprises, township and village-owned entities and foreign-owned businesses.
The domestic capital market system in China, which generally includes two major stock exchanges, the Shanghai and the Shenzhen, is the domain of the state owned entity (SOE). The listing requirements on these exchanges are stringent and often beyond the reach of the vibrant and growing SMEs which have not reached the critical mass to list on either of these exchanges. In addition, the waiting periods to list on these exchanges exceed three years. In fact, a recent ruling by the China Securities Regulatory Commission provides that any restructuring done by a company which is waiting to list on an exchange would serve to restart the clock on the waiting period, even in a situation in which the company was about to satisfy the waiting period. In effect, this creates a perception and a reality to the SMEs that these stock exchanges do not want them. Based upon my conversations with numerous private sector companies and entrepreneurs, this is considered to be the conventional wisdom in China.
Another major source of outside financing, in China and anywhere else in the world, is debt financing from a commercial bank. However, Chinese commercial banks do not provide a reliable financing mechanism for SMEs. From a common sense point of view, this has to do with the psychology under which commercial bank loan officers operate. Such officers are not rewarded in terms of compensation or advancement, upon the making of “good” loans to fast growing enterprises in the private sector, but are penalized for making bad loans to these enterprises. Therefore, the extension of credit to these enterprises is conservative in general. If an SME does manage a commercial bank loan, most such loans have short repayment periods, typically six months or one year, and thus do not serve as a realistic source of financing for any projects with time horizons exceeding one year.
Given the limitations of obtaining outside financing in China, many SMEs finance growth through internal financing sources such as obtaining loans from friends and family and angel investors known to the senior management. We have also seen a number of companies which have financed growth from their own retained earnings year to year. Of course such internal financing has severe limitations, thus compelling the need for another capital markets solution. For a number of companies, this other solution has been seeking a listing overseas in the Hong Kong or Singapore exchanges.
From a business perspective, a listing on the Hong Kong or Singapore exchanges, which are generally regarded as regional Asian stock exchanges, presents limited investor access relative to a U.S. listing. The market capitalization of these exchanges is far less than the New York Stock Exchange or NASDAQ; in fact the entire market capitalization of the Hong Kong exchange is encapsulated in a few of the larger issues on the NYSE or the NASDAQ. There are a number of technical reasons why a listing on these exchanges is unfavorable from the listing company and prospective investor perspectives. The relative valuation of companies listing on these exchanges tends to be much less compared to the valuations on the U.S. capital markets for similarly situated companies. Based upon our research, the average price/earnings multiple obtained by a company listing on the Hong Kong or Singapore exchanges is approximately 15. We have examined recent listings of Chinese companies in the U.S. capital markets, and our research indicates that, on a conservative basis, such companies have experienced price/earnings multiples exceeding 30 on average on the U.S. exchanges including the NYSE, NASDAQ and AMEX.
Corporate governance has become increasingly significant in recent years in the U.S. and internationally. The passage of the Sarbanes-Oxley Act in 2002, and the increasing focus on such issues internationally, has highlighted the relevance of such issues to Chinese companies seeking listings on U.S. and international exchanges. Institutional investors have been paying special attention to such issues with respect to Chinese companies. However, the Hong Kong exchange in particular continues to operate under an apparent conflict of interest. The same entity which operates the Hong Kong exchange and earns fees from such listings, Hong Kong Exchanges & Clearing, also has the authority to regulate the listings, including initial listings of companies. Most experts on the Hong Kong stock market believe that such regulatory authority should be in the hands of the Securities and Futures Commission. We believe that this makes a listing on the Hong Kong exchange a bad idea for both the listing company and investors. One of the primary reasons that companies list on stock exchanges is to attract quality investors. If the internal conflicts of interest in a stock exchange make it unfavorable to institutional and other sophisticated investors, the exchange should be avoided.
At New York Global Securities, we believe that Wall Street is the answer to the financing quandaries of Chinese companies. Our research indicates that China-based companies raised approximately $24 billion in initial public offerings in U.S. capital markets in the period 1993 to 2001, and approximately $5 billion overall in the U.S. capital markets in the period 2001 to 2003. Projections for 2004 for capital raised by China-based companies via initial public offerings range from $15 to $23 billion. This dwarfs the approximately $7.5 billion raised from new issues in the Hong Kong market in 2003.
A U.S. listing of a China-based enterprise results in a positive solution for both the company and the prospective investor. Unlike a listing in the domestic Chinese exchanges, a listing in the U.S. is a matter of process and not politics. If a company meets the quantitative financial requirements and qualitative corporate governance requirements of the relevant exchange, the company is qualified to become a U.S. listed company. As a U.S. public company, the China-based company becomes subject to the auspices of the U.S. Securities and Exchange Commission, and is accountable for all of the SEC requirements of a U.S. public company such as periodic reporting on Forms 10-K and 10-Q. Among other factors, a board of directors with independent board members, and improved internal accounting procedures serve to increase the transparency of the China-based company, to the advantage of U.S. investors. In fact, based upon our research, China-based companies listed on the NYSE and NASDAQ presented an average return exceeding 300% in the period from 2002 to 2003.
A U.S. listing of a China-based company has relative advantages to listing over other global markets, as well as over other sources of financing available to such companies. The returns enjoyed by U.S. investors in such companies also present a unique opportunity in the global markets. The increased transparency and resultant investor legitimization of such companies is an important trend for the future of Chinese companies, and we look forward to working with more Chinese companies in the future.
Thank you for your kind attention.