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Chinese IPOs underpriced by up to $200bn due to valuation limits

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Initial public offerings in China have undervalued companies by up to $200bn over the past six years, academic research indicates, reflecting a struggle to price listings in the world’s second-biggest equity market.

Limits on the valuations at which companies can sell shares in IPOs on most Chinese bourses mean that groups listing onshore may have raised just a quarter of what they otherwise could have, according to a working paper provided exclusively to the Financial Times by researchers at the University of Hong Kong.

Researchers determined the extent of IPO underpricing by tallying up the early share price gains across almost 1,300 market debuts from 2014 to July 2020 on the main stock exchanges in Shanghai and Shenzhen, as well as the latter’s tech-focused ChiNext market and its small business-oriented SME Board.

They found new stocks jumped on average 300 per cent on their debut following reforms in 2014, compared with just 37 per cent under a previous listings regime.

That underscores the challenges Beijing faces in making its markets more attractive for Chinese companies looking to float, analysts said. US-Sino tensions have made that task more urgent, with $1tn of Chinese equity listings at threat of being evicted from Wall Street under draft US legislation.

“We’ve not moved forward in 20 years — that, I think, is the bigger picture of what this work shows,” said Fraser Howie, an independent analyst and expert on China’s financial system.

Chinese authorities have for decades oscillated between a market-driven regime for pricing IPOs and one in which regulators have a greater say.

For about a decade after the Shanghai Stock Exchange reopened in 1990 following a more than 40-year hiatus, government regulators required most IPOs to price well below their market value. That let retail traders, who could subscribe to IPOs through a lottery system before shares hit the market, benefit from a massive jump on the first day of trading.

But by about 2009 regulators had moved towards an auction-based system for pricing IPOs more akin to those in New York, Hong Kong and London. That meant retail and other investors were far less likely to enjoy big price rises on the first day of trading.

Those reforms drew the ire of investors, according to Andrew Sinclair, a co-author of the University of Hong Kong paper.

“The idea of the IPO pop on the first day, that was something people had come to expect, but that was an artefact of inefficiencies in the market,” Mr Sinclair said. “When it became more efficient that was something that completely broke their expectations.”

China’s IPO pop returns with a vengeance

Following a chorus of criticism by local financial media and academics, which argued that the new system funnelled more money to already wealthy entrepreneurs, the China Securities Regulatory Commission in 2014 in effect imposed a limit that meant most companies could only list their stock at a maximum value of 23 times earnings per share.

Mr Sinclair said that created “a huge incentive to start listing abroad” for Chinese technology groups. Alibaba’s $25bn New York IPO in September 2014, at the time the world’s biggest, valued its stock at a price-to-earnings ratio of 40 times.

China has recently begun to experiment again with market-driven pricing for IPOs. Those on Shanghai’s tech-focused Star Market, which was hailed by state media as “China’s Nasdaq” during its launch in 2018, are not subject to valuation ceilings. Shenzhen’s ChiNext, another tech-centric market, has followed suit.

“Given all the reforms . . . companies can now sell their stocks at more market-driven prices,” said Kinger Lau, chief China equity strategist at Goldman Sachs. “I think that creates extra motivation for Chinese companies to issue.”

Yet listings on Star, which were not included in the University of Hong Kong research, have enjoyed an average day one jump of 160 per cent since the market launched, according to data from Dealogic. Shares in tech group QuantemCtek climbed a record 924 per cent on their debut in June.

By comparison, first-day IPO gains on the Nasdaq and New York Stock Exchange have averaged about 19 per cent and 12 per cent in the same timeframe, respectively.

Listings reforms put a cap on Chinese IPO valuations

Bruce Pang, head of research at investment bank China Renaissance, said that Star IPOs’ pricing reflected a “compromise” between the interests of issuing companies, retail traders and investment banks.

Star IPO sponsors must invest in the companies they bring to market with a two-year lock-up period. That is supposed to ensure bookrunners do not try to offload overpriced shares in shoddy companies to investors, but also incentivises them to price IPOs low enough to ensure a juicy return.

“If you’re a broker underwriting these listings you have to put up some of your money to invest in these companies, so you’d want more upside,” Mr Pang said.

The arrangement is not without its critics, however. Mr Howie, the independent analyst, described it as a “direct conflict of interest”.

“Ultimately it’s the companies themselves which are suffering” due to limitations on IPOs, he added. “Selling two dollars for one dollar never makes any sense.”



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Deliveroo picks London for IPO after listings review

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Deliveroo has chosen London for its highly anticipated initial public offering after Rishi Sunak, the UK chancellor, endorsed an overhaul of listing rules to allow founders to retain more control after going public. 

The multibillion-pound IPO is expected to be among London’s largest this year, handing the City a much-needed win over New York and Amsterdam at a time of feverish activity in new tech listings. 

“Deliveroo is proud to be a British company, and the selection of London as its home for any future listing reflects Deliveroo’s continued commitment to the UK,” said Claudia Arney, Deliveroo’s chair. 

Deliveroo’s decision follows the publication on Wednesday of a review by Lord Jonathan Hill, former EU financial services commissioner, which recommended a wide range of reforms to loosen listing rules in the UK. 

Among Hill’s recommendations were proposals to allow dual-class share structures, which allow founders to hold on to extra voting rights after an IPO, to be used by companies trading on the London Stock Exchange’s “premium” segment. The dual-class arrangement is popular in Silicon Valley, where it is used by companies including Facebook and Google parent Alphabet. 

The move, which Sunak endorsed during Wednesday’s Budget, was designed to attract fast-growing tech companies such as Deliveroo, though some London fund managers fear the change puts shareholder protection at risk.

Deliveroo said in a statement on Thursday morning that its dual-class structure would be “closely in line” with the Hill review’s recommendations and be limited to three years. However, the changes are unlikely to come into force before it has completed its IPO, with initial paperwork expected to be filed as soon as next week.

Companies with dual-class structures can already trade on the LSE’s standard listing. Once the new rules are in place, Deliveroo would be able to move up to a premium listing. A person close to the company said that the Hill review was also likely to attract more tech companies to London, making it more attractive as a listing venue overall.

“Alongside the dual-class share structure, Deliveroo intends to have a strong commitment to corporate governance standards including a majority independent board of directors as well as upholding diversity standards,” the company said. 

Will Shu, Deliveroo’s co-founder and chief executive, said he was “proud and excited” to list in London, where the company first began making restaurant deliveries in 2013. 

Sunak hailed the decision as “fantastic”. 

“Deliveroo has created thousands of jobs and is a true British tech success story,” he said in a statement. “It is great news that the next stage of their growth will be on the public markets in the UK.”

Arney added: “London is not just where Deliveroo was born, it is one of the leading capital markets in the world, with an incredible technology ecosystem, sophisticated investment community and a skilled talent pool. The time-limited dual-class structure would provide Will and his team with the certainty needed to execute against their ambitious growth plan to become the definitive online food company.”



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Investors push back against UK listings overhaul

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London’s biggest fund managers have pushed back against proposals to liberalise the City’s stock market listings regime, saying changes aimed at luring in technology businesses and special purpose acquisition companies risk “watering down” investor protections.

A report by Lord Jonathan Hill, published on Wednesday, recommended allowing dual-class share structures for companies admitted to the London Stock Exchange’s “premium” segment, and lowering the limit on the free float of shares in public hands from 25 per cent to 15 per cent, meaning founders need to sell less of their business to list it. He also laid out proposals to make the UK a stronger potential venue for listings of blank-cheque companies known as Spacs.

UK companies and the country’s main listings venues, the LSE and Aquis Exchange, said the plans were vital to improving London’s attractions in a globally competitive market. But some investors are nervous.

Chris Cummings, chief executive of the Investment Association, the trade body that represents asset managers with a total of £8.5tn in assets, said the proposals were an “important first step”, but he warned that the UK needed to ensure “appropriate investor protections for minority shareholders”.

One large investor in UK-listed companies said it was strongly opposed “to the watering down of rules governing premium listing”. “Shareholder protections should not be used as a bargaining chip to prove the UK is open for business,” the investor said.

Another large global asset manager said the current standards for premium listings, including the principle of “one share, one vote”, were “critical”.

“The UK has gold standards for stewardship,” the fund manager said. “If we are going to create more flexibility for a listing, we would want over time [for companies to] work towards a premium listing with ‘one share, one vote’ and standard free float with sufficient liquidity.”

Some asset managers took a more upbeat view of the Hill review.

“Schroders is in full support of Lord Hill’s review. It is crucial that we do all we can to make the UK the most attractive place for companies to list and to do business for the benefit of investors,” said Peter Harrison, chief executive at Schroders, the biggest listed UK fund manager.

Hill’s proposals are intended to boost London’s global standing as an equity market, which has weakened in recent years as the US and Hong Kong have swept up the majority of in-demand tech listings. New York’s markets have also gained a boost from a wave of Spacs, which raise money from investors and list on a stock market, then look for an acquisition target to take public.

The departure of some large technology stocks such as Arm in recent years has cemented the blue-chip FTSE 100 index’s bias towards financials, energy and mining stocks. A loss of trading businesses to European rivals since Brexit has also further dulled the allure of the City.

The Hill recommendations are “smart, pragmatic measures”, added Sir Martin Sorrell, whose S4Capital digital market and advertising business has a dual-class share structure. “[It] also signals that the government’s ‘Singapore on Thames’ vision for a post-Brexit Britain is on the way to becoming a reality,” he said.

Makram Azar, chief executive of Golden Falcon, the European technology blank cheque company that opted to list in New York, said London needed to make significant structural changes.

“The recommendations will no doubt spur investors to look at listings on the LSE in the future. It will take time to develop the whole ecosystem around Spac listings in London, but this is the start of the sea change that’s needed.”

Others cautioned against the risks of making changes to attract blank cheque companies.

“Spac deals may be booming in the USA right now, but fear of missing out is just about the worst possible reason for making any investment decision,” said Russ Mould, investment director at stockbroker AJ Bell. “It is therefore to be hoped that the FCA maintains its critical faculties when it assesses Lord Hill’s proposals and the safeguards that he offers alongside them.”



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Oscar Health raises $1.4bn from stock market listing

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Oscar Health, the health insurance company co-founded by Joshua Kushner, raised more than $1bn in an initial public offering that topped the company’s marketed price range, in a sign of investor confidence despite political uncertainty over the future of US healthcare.

The New York-based company priced its shares at $39 each on Tuesday, according to a statement, raising about $1.4bn. Oscar would have a market capitalisation of $7.9bn at that price, based on the total number of shares outstanding.

Oscar previously said it expected its listing share price to range from $32-$34 before increasing the range to $36-$38 on Tuesday. Coatue Management, Dragoneer Investment Group and Tiger Global Management — existing investors in the company — had indicated interest in purchasing up to $375m of shares in the offering.

The move demonstrated that investors are relatively unfazed by potential headwinds for the company. President Joe Biden has vowed to reform the US healthcare system and the Supreme Court is considering a decision on the fate of the Affordable Care Act, known as Obamacare, both of which could pose significant challenges to Oscar’s operating model.

Oscar was co-founded in 2012 by Mario Schlosser and Joshua Kushner, the brother of Jared Kushner, Donald Trump’s son-in-law. Kushner’s venture firm, Thrive Capital, owned a stake that would be worth $1.3bn at the offering price and give it 75.9 per cent of the company’s voting power.

Oscar, which bills itself as the first health insurance company “built around a full stack technology platform”, has more than half a million paying members and offers its insurance plans in 18 US states.

But the company has struggled to become profitable. In 2020, it recorded widening losses of more than $400m on revenues of about $460m, a decline from almost $490m of revenues the previous year.

Oscar’s IPO came on the heels of several other public market debuts for “insurtech” groups in the past year, which fuelled an already strong run of stock market listings.

Clover Health, which uses data analytics to connect senior citizens to Medicare Advantage plans, merged with a special purpose acquisition company, or Spac, sponsored by former Facebook executive Chamath Palihapitiya in a $3.75bn deal in October. Lemonade, which sells rental, homeowners and pet health insurance, went public last summer in what turned out to be one of the year’s most successful stock market debuts.

Oscar is highly sensitive to any changes to Obamacare, which lawmakers have wrestled over since it was written into law in 2010. Almost all of the company’s revenue comes from plans subject to Affordable Care Act regulations, according to its prospectus.

President Joe Biden’s healthcare programme would leave Obamacare largely intact, but would make some adjustments and add a public option for all Americans. The Supreme Court, meanwhile, is expected to announce a decision on yet another review of the Affordable Care Act in the coming months.

Goldman Sachs, Morgan Stanley and Allen & Co led the offering.



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