U.S. investors have been enthusiastically investing in Chinese businesses listing on U.S. exchanges in order to achieve returns that were believed to exceed those available in lower growth Western economies, including the U.S. Ironically, Chinese businesses have been buying U.S. businesses and assets in record amounts because of the opportunity for growth the U.S. offers. Can these seemingly disparate strategies both work?
There are nearly 340 Chinese companies listed on the NYSE, NASDAQ or OTC markets. Approximately 20 percent of these Chinese companies joined U.S. exchanges during the previous four years hoping to cash in on U.S. investor appetite for Chinese growth stocks. Now some of those companies are pulling up stakes. Investor enthusiasm collapsed after allegations raised concerns about accounting improprieties and deficiencies in corporate-governance standards at dozens of Chinese companies.
One index suggests Chinese companies lost 52 percent of their market value during the past year. This means that many U.S. investors lost not only the initial positive return on their investment but also a portion of the initial investment they made in these Chinese companies. Adding to the uniqueness of the investment was the fact that many of these Chinese businesses did not have operations or serve any markets in the U.S. The companies listed on U.S. exchanges in order to raise capital to expand in other parts of the world, and investors sought access to these opportunities.
The stigma attached to Chinese-listed companies has resulted in lower returns for nearly all but the largest Chinese-listed companies. For most, the promises of additional share issuances and access to debt financing seems to be out of reach. As a result, China Development Bank, the state-owned lender charged with strengthening the country’s competitiveness, is providing more than $1 billion in financing to help companies buy back shares from the public and go private. A silver lining is that shareholders are receiving approximately 20 percent more in the buybacks than they would have received if they had sold their shares at the closing price on the day before the offer.
Regaining the confidence of U.S. investors requires a coordinated effort that goes beyond current regulations. The SEC and the Chinese Securities Regulator should agree on the development of an interactive communication platform to supplement current financial reporting requirements. Such a system would allow investors to look up information about the companies they are interested in and also check the feedback from other counterparties who do business with the company. Development of Chinese companies in the U.S. is not just a commercial issue but a political issue. Accounting transparency, consistent development and effective communication platforms are essential to Chinese companies to rebuild investor confidence.
While U.S. investors may look abroad for better returns, Chinese companies, facing an economic slowdown at home, are plowing money into U.S. assets at a record pace, making huge bids for American energy, aviation, entertainment and other businesses. The increase in investment comes despite lingering American anxieties about potential breaches of national security and loss of technology to the powerful Asian competitor. With U.S. real estate prices depressed and many firms in the West starved for cash, the Chinese see a prime opportunity to rummage through the bargain bins of rich countries to gain technological know-how and international reach.
The Chinese growth model is changing fundamentally as Chinese companies escape the profit squeeze in low-end manufacturing and move up and down the value chain. Expanding investment in developed economies is an essential part of this business evolution. Natural resources remain a major target for the Chinese, who have scoured the globe for oil and minerals to fuel the nation's rapid industrial development. Across other industries, Chinese corporations are buying into American companies for their prowess in branding, marketing and research capabilities. One recent example is a Chinese auto parts giant providing a $465 million rescue package for struggling battery maker A123 Systems Inc., based in Waltham, Massachusetts, giving one of China’s biggest private companies a chance to buy a majority stake in a world-class battery developer for electric cars.
Chinese companies will continue to seek access to capital outside its own borders because the Chinese securities markets are not yet as deep and transparent as those in other parts of the world. In particular, capital access is still difficult for smaller companies in China. However, many times, smaller companies are an important source of technological innovation. U.S. investors should not be deprived of such investor opportunities that should be available to them with the benefit of additional transparency that goes beyond traditional and current regulations. In addition, Chinese investment in U.S. businesses is a normal aspect of global growth. There is no need to fear this investment since joint collaboration can provide enormous benefit to both economies and societies.
Steven L. Henning, PhD, CPA, is the Partner-in-Charge of the Litigation and Corporate Financial Advisory Services Group of Marks Paneth & Shron LLP.