BUYOUTS: Regulator Re-think Boosts Privatizing China Stocks

Bottom line: The CSRC’s reported plans for a backdoor listing quota for companies returning to China from New York should restore confidence that well-conceived buyout plans by big names like Qihoo will succeed.

Regulator reopens gate for backdoor listings in China

After a massive sell-off at the beginning of the week on concerns of a major new roadblock to their homecoming plans, Chinese companies privatizing from New York have seen their shares rebound sharply on reports of a regulatory compromise that would allow them to re-list in China. The story is mostly based on rumors about an internal debate within the China Securities Regulatory Commission (CSRC), China’s stock regulator, which is worried about a potential future flood of backdoor listings by local companies now privatizing from New York.

The sell-off for companies like Qihoo (NYSE: QIHU), Momo (Nasdaq: MOMO) and 21Vianet (Nasdaq: VNET) at the start of this week came after reports emerged saying the CSRC might halt all such backdoor listings, which typically see a company inject its assets into an existing listed shell company. The regulator took the unusual step of saying it was simply studying the issue, but that didn’t ease concerns that New York privatization bids for Qihoo and others might collapse if backdoor re-listing route in China was closed.

Now the latest reports are saying the regulator is leaning towards a compromise plan that would allow backdoor listings to continue but at a controlled pace. (English article) Those reports helped shares of Qihoo to bounce back from their earlier losses, rising nearly 9 percent in the latest session on Wall Street. Momo and Vianet also rose 6.6 percent and 15 percent, respectively, though both are still down from levels before the rumors began.

Earlier this week I also called on the regulator to take a less drastic approach than the more severe ban on backdoor listings that was reportedly being discussed. (previous post) Around 4 dozen Chinese companies have announced plans to privatize from New York since the start of last year, believing they could get higher valuations by re-listing back in their home market.

But a huge backlog of other companies currently waiting to list in China meant that most of these privatizing companies might have to wait years for a chance to re-list at home through conventional IPOs. Thus many were considering backdoor listings as a quicker alternative, and 2 such firms, Focus Media and Giant Interactive, are both in the process of making such listings.

Quota System

The latest reports cite knowledgeable sources saying the CSRC is considering a system that would create a backdoor listings quota for returning companies. Even if all of these companies re-listed in China, their total market value would probably be around $30 billion or less, which is quite a small for a market of China’s size. Allowing such backdoor listings would also help to clean up China’s markets of many shell companies whose own businesses have largely failed but refuse to de-list.

Of course everyone will now be watching for some concrete actions from the CSRC to see how it will proceed. A reasonable approach would be to limit the number of backdoor listings to perhaps around 15 per year, which should be easy for China’s stock markets to absorb and would also add some attractive private-sector options for local stock buyers.

The reality is that these privatizations and backdoor re-listings are extremely complex, which is why there’s no guarantee they will succeed. Of all the companies that announced privatization plans last year, only a small fraction have actually de-listed and even fewer have managed to make backdoor listings in China.

All that said, adoption of a quota system by the CSRC should help to restore confidence that well-conceived plans like Qihoo’s will ultimately succeed. But shakier plans by many of the other companies are still quite likely to fail, and I expect that less than half of all the previously announced privatization plans will ultimately succeed.

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