Why
are so many Chinese companies choosing to raise money in the west? At
least 80 stocks from mainland China or HK are now listed on Nasdaq,
making it the third most popular source of foreign Nasdaq listings
after Canada and Israel, according to this Wall Street Journal ($) article.
The number of China plays quoted on AIM, London's junior market, has doubled in the past year to 36 and London Asia Capital, the Asia-focused merchant bank, has at least eight more candidates waiting in the wings.
While there are a handful of big well-established China plays like China Mobile or Baidu listed in the west, most are small companies focussed on emerging sectors like biofuels, renewable energy and software. Many of these minnows have limited trading history. Some have little more than a name and a business plan.
Astute readers will have spotted the answer to the opening question already. These China businesses are really early-stage companies that have chosen to go public in the west rather than try to raise venture capital back home
Indeed, if they were based in west, some would probably still be dependent on their VC backers. But China has a very underdeveloped VC market, so instead Chinese entrepreneurs are turning their sights on Nasdaq or London's AIM for early-stage funding.
The Mr Wave Theory blog argues that its possible to make large amounts of money investing in these little-followed China stocks -- EngagingChina simply reports his comments and and does not offer investment advice.
Stocks like China Technology Development offer western investors the opportunity to invest in early-stage growth companies that would otherwise be unavailable to retail investors, according to Mr Wave Theory, who claims to be a retired Silicon Valley venture capitalist.
Never heard of China Technology Development? Its a HK-based company that, bizarrely, sells both network security systems and dietary supplements to China. Mr Wave Theory claims its a perfect example of a small Chinese company that offers VC-type returns to investors.
However, its definitely not a stock for widows and orphans. In 2005, the company made an operating loss of $2.1m on revenues of less than $1m. The company's share price regularly quadruples in a few days, only to later give up the gains. It was also recently threatened with delisting.
In the case of China Energy Savings Technology, the delisting threat was carried out and the company is now traded on the Pink Sheets -- a back water for speculative stocks. It also faces several class action suits.
China Energy Savings Technology was set up to sell energy-saving products for the Chinese market and in its last quarterly filing to the SEC, it predicted "strong demand" for its products due to electricity shortages in many parts of China. However, the filing also revealed the SEC was conducting an informal inquiry into the company. Trading on Nasdaq was suspended the next day.
At first sight, energy-saving technologies and network equipment both seem equally good ways to play China's new economy. So too, might selling ring-tones, although several China plays have stumbled on this market as well -- see this EngagingChina story.
And that of course is the problem. The unsophisticated investor in the west has no real way of judging the business plans of these China plays, or really understanding their related-party transactions, capital structures and accounting policies.
This whole sector needs to be looked at through the lens of a venture capitalist. That means for every China play that goes on to produce rich rewards there will be at least ten that will fail, sometimes, like China Energy Savings Technology, in spectacular fashion.
Of course, VCs know this and they know how to manage the risk. The problem is that most private investors do not. Indeed, the excellent ChinaLawBlog predicts a growth industry in shareholder class action suits against western-listed Chinese companies, "starting very soon."
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