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IPO reform and the new reality

Even after China re-opens the IPO markets, companies considering a listing may decide to seek other exit routes. Bonnie Lo, partner at NewQuest Capital, explains why.

When China’s long-standing IPO wall starts to slowly breakdown, listing candidates will find a new environment. The China Securities Regulatory Commission is currently reforming the share listing system, which includes measures such as streamlining underwriting procedures and broadening information disclosure rules.

There is still much uncertainty about when markets will re-open and what to expect when they do. Initially, IPOs were supposed to resume in April 2013. Media reports are now saying October. When the day does come, companies will find that the bar has been raised for listing candidates, resulting in a longer road to an IPO than before.

Hundreds of companies in the queue are considering other options to access capital for future growth. GPs invested in such companies will need to see how the reforms may impact their portfolio management.

There are two risks to highlight in the IPO approach:

Firstly, the new listing regulations have more detailed policies, which limit the number of companies eligible for IPO by size and calibre. This is positive for long-term development of the public stock markets in China, but poses a problem for SMEs that originally had their eyes on a near-term IPO.

The holding period of the private equity firm which invested in the company five years ago could be extended another five years due to the regulatory hurdles to listing as well as expected lock-up period

Secondly, the CSRC is expected to impose further requirements on significant shareholders of potential IPO candidates, according to a draft paper issued by the CSRC in July 2013. For minority shareholders: “Significant shareholders (>5%) shall disclose their intention to hold and/or sell the shares after IPO…”  When selling shares post-IPO, such significant shareholders will be subject to more stringent disclosure requirements.

For controlling shareholders: “Controlling shareholders commit that for a period of two years after their statutory lock-up period, the selling price of their shares shall not be less than the issuing price”. In addition, “If the average trading price during the first six months of the listing is less than the issuing price, their lock-up period will be automatically extended by another six months.” 

While A-share IPOs will ultimately make a comeback, these new requirements may nonetheless cause some companies and shareholders to re-think whether listing is their best option.

When the CSRC closed the IPO door in late 2012, investors began exploring ways to exit, including: 

a) wait and hope to get through the CSRC’s new approval process
b) list on other exchanges such as Hong Kong or US (including the much-anticipated “small H-share” opportunity)
c) sale of their stake (secondary sales)
d) sale of the entire company

In this climate, option c, secondary sales, is becoming a viable option for providing an exit to investors and creating value for companies looking for more time to grow before an IPO, or for additional capital or new investor support. 

Here’s an interesting case study that we’ve come across: A company is IPO-ready in terms of size and has support from local governments; however, it had to undergo shareholder restructuring to qualify for listing. The change-of-control triggered by the shareholder restructuring in turn resets the three-year track record requirement to apply for IPO. Therefore, the company has no choice but to do the restructuring and wait for three years to apply for listing.  

The holding period of the private equity firm which invested in the company five years ago could be extended another five years due to the regulatory hurdles to listing as well as expected lock-up period. A sale of its shares may now be the investor’s best option for exit.

The momentum of the private equity secondary market therefore will continue to grow, as existing investors turn to alternative routes for liquidity. In the US and Europe, secondary sale exits as a percentage of total exits are about 50 percent. In China, the number is around 10 percent, but the share listing reform will likely push that figure higher.

Bonnie Lo is a partner and co-head of China business at NewQuest Capital Partners in Hong Kong.