Safety/Risk Model - Going Public
posted by The Traveller on Sunday, January 30, 2011

(Back to Introduction)

Going Public

(accounts for 10% of the final score)

Market Segment / Exchange (50/100)

The standards for an initial and continued listing vary greatly between the exchanges and respective market segments. Those standards include financial, liquidity and especially also corporate governance requirements. The requirements for the NASDAQ markets can be found here. In our model, a company that meets the highest standards will score full points in this category, a pink sheets quoted stock that is not fully reporting will score zero points.

  • 50/50 - NASDAQ Global Select, NASDAQ Global Market, NYSE
  • 40/50 - NASDAQ Capital Market
  • 30/50 - NYSE Amex
  • 10/50 - OTC Bulletin Board quoted
  • 0/50 - Pink Sheets
Type of Going Public (50/100)

The three most common ways for a Chinese company to go public in the U.S. is via Initial Public Offering (IPO), a reverse takeover into a public shell company (RTO, Reverse Merger), or via business combination with a SPAC (Special-Purpose Acquisition Company) or blank-check company. For investors, an IPO provides the highest degree of safety as those companies are generally more mature, went through much more thorough due diligence by the involved investment banks and the public with the IPO process, and they start out trading on a senior U.S. exchange with significantly higher liquidity, market support and the backing of well-connected Wall Street firms with a reputation at stake.

While RTO stocks are not inherently bad, the risks for investors are significantly higher here. Reverse Mergers provide a much cheaper and faster path to getting listed than regular, underwritten IPO's, and for an early-stage growth stock from China this is often the only way to get access to the U.S. capital markets. But for determining the risks in a particular RTO deal, we have to dive into several, often blurry details. What is the history of the shell company, is it clean, who are the current players and promoters involved in the shell? Who owns the company post-merger, what is their history? Do U.S. financial advisors involved in the merger now hold a position in the company? Did they install an investor relations firm, law firm, accounting firm?

  • 20/20 - regular Initial Public Offering
  • 10/20 - SPAC / Blank-Check
  • 0/20 - Reverse Merger or Self Filing

While we acknowledge a higher safety profile for IPO stocks, we also see a possible difference in the quality of Initial Public Offerings and their lead underwriters. An offering led by a tier one Wall Street firm with the highest reputation in the market will score higher in our model than IPO's led by relatively small firms that are specialized on small-cap China deals. We have grouped all relevant investment banks into two categories, based on Renaissance Capitals statistics for lead underwriters in 2010. The data going into this ranking is Average Deal Size, Proceeds Raised, and Average IPO Returns.

  • 30/30 - Tier One Lead Underwriter (Barclays Capital, BofA Merrill Lynch, Citi, Credit Suisse, Deutsche Bank Securities, Goldman Sachs (Asia) L.L.C., Goldman, Sachs & Co., J.P. Morgan, Morgan Stanley, UBS Investment Bank, Wells Fargo Securities)
  • 15/30 - Tier Two Lead Underwriter (Baird, Broadband Capital, Cowen & Company, Global Hunter Securities, Keefe Bruyette Woods, Leerink Swann, Maxim Group LLC, Morgan Joseph, Oppenheimer & Co., Piper Jaffray, Raymond James, Rodman & Renshaw, Roth Capital, Stifel Nicolaus Weisel, Suntrust Robinson Humphrey, Thomas Weisel Partners, William Blair, Wunderlich Securities)
  • 0/30 - Unranked Lead Underwriter or none at all (non-IPO stocks)
Dual Listing

U.S. listed China stocks that are also listed on a domestic Chinese exchange (Shanghai, Shenzen, Hong Kong) provide a much higher degree of safety for U.S. investors. Those stocks are usually listed in the United States in the form of American Depository Receipts (ADRs), and only Chinese companies with the best financial integrity and corporate governance can usually achieve such a dual listing. Another form of dual listing we acknowledge in our model is the listing of the main operating subsidiary on a domestic exchange. There are very few examples of such a dual listing as the requirements for an IPO in Shanghai or Shenzen are very high. A company that has recently announced a plan to list their subsidiary on the Shenzen exchange is Wonder Auto Technology (WATG), but we would expect this process to take up to one year - if successful. A clearance through China Securities Regulatory Commission supports the legitimacy of the company and its corporate structure, which leads to a much improved safety profile for the U.S.-listed company. In our model a successful dual listing leads to an UPGRADE of the Safety/Risk Score.

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