Succeeding as a public company

Transcription

1 JPM Shanghai Roundtable reprint.qxd 12/7/09 10:56 AM Page 1 Succeeding as a public company J.P. Morgan and FinanceAsia Depositary Receipts Roundtable Report

2 DEPOSITARY RECEIPTS ROUNDTABLE Succeeding as a public company The essential ingredients before, during and after an IPO moderated by Nick Ferguson and Ivan Peill Global equity markets rallied in the second half of 2009 but the conditions are still challenging for new issuers. The credit crisis and the US recession have significantly changed the capital markets, with valuations, exit opportunities, fund-raising and deal-making all dramatically affected. In November, we gathered together a group of specialists to discuss how these market conditions are affecting the IPO market and how industry players need to adjust to ensure that the journey from privately-owned business to public company is successful, on listing day as well as for the long term. The first step on the journey to an IPO is often investment from private equity. How do PE firms work to transform a privately owned company into one that can be listed publicly at a good price? Tim Zhang: Most of the companies we look to invest in are not ready to do an IPO because when entrepreneurs start a business they don t start with best practices in accounting, management and so on. When they decide to go to the next step, to improve their management and their corporate governance, that s when they start to look for private equity help. That s where we come in. The fundamentals of the company are key to a successful IPO. There are certain criteria that basically describe the qualities of a good candidate for an IPO in the future: a leadership position in the market; a seasoned, proven management team; the required corporate governance in place; transparent book-keeping and so on. These PARTICIPANTS Kenneth Tse Asia-Pacific head of depositary receipts group, J.P. Morgan Tim Zhang China head of global special operations group, J.P. Morgan Richard Li chief development officer, GCL Poly Energy Holdings Sally Shan Asia head of technology, investment banking, J.P. Morgan Leiming Chen partner, Simpson Thacher & Bartlett Jeffrey Fu partner, Deloitte Touche Tohmatsu, Beijing Jonathan Zhang chief financial officer, BJB Career Education Company Richard Wei chief financial officer, Shanda Games MODERATORS Ivan Peill ADR IR advisory services, J.P. Morgan Nick Ferguson co-deputy editor, FinanceAsia are the ingredients that will make a successful company in the public markets, as long as the timing is right. Richard, you tried to list in the US last year. What are your views on timing? Richard Li: As a company, you ve got to take the chance once it s there. It could be complicated for a company like ours because of pre-ipo financing and structuring, since there were some financial hurdles to overcome. We postponed the IPO due to the financial crisis and also because we wanted to get the highest value for our shareholders. When you have pre-ipo investors they expect higher returns. If you accept a low valuation in IPO, they might expect some adjustments for their returns. This position can sometimes make things difficult, but you have to look at what s best for the company s long-term development. It s not only about the raising of one-time proceeds, but also about establishing a platform for growth. What role can pre-ipo M&A play in preparing a company to go public? T Zhang: It s very difficult to borrow money from the bank for M&A, so it is wise for any company in the growth stage to look to private equity for help. It s quite common for companies we invest in to make a series of acquisitions to expand their business lines and to enhance their core competencies before they get ready to do a successful IPO. We don t just provide long-term capital to the business but also bring a lot of experience in mergers and acquisitions how to find the right target, how to execute PICTURE CREDIT: AFP

3 Ivan Peill the deal and how to integrate the business after the acquisition. Sally, could you share an investment banker s thoughts on the run-up to an IPO? Sally Shan: It s really about understanding the environment and not just focusing on maximising the IPO price. We help the management and the board understand the market situation and timing, and what is a reasonable valuation given the prevailing market conditions. Entrepreneurs are always very proud of their business and have their own views on pricing, so it s our role to help companies to understand valuations. Maximising the IPO price is not necessarily good for all the different parties an IPO is just the first step for the company in the public eye. You have to leave some room for your future, though obviously if your stock jumps 50% on day one the deal is not properly priced. On the other hand, continued downward pressure on the stock will make everyone s life difficult. Finding that fine balance is an art. Leiming, you have advised many Chinese companies on listing overseas in the US and Hong Kong. What are the biggest legal challenges they face? Leiming Chen: We spend a lot of time working with pre-ipo companies to set up the proper legal structure, but there are two areas I see that have a long-term impact on the life of each of those companies as a public company: corporate governance and internal controls. A lot of non-state owned enterprises [non-soes] are generally started with a small group of founders or as familyrun businesses, and making decisions that take small minority shareholders into consideration is not something they are inherently used to. They want to go public, but they also tend to have the need to keep some level of unfettered discretion in decision-making. Private equity and venture capital firms can be helpful in that process, because when they invest in a pre-ipo company they will often impose some level of corporate governance and internal controls requirements, which serves as a good starting point for the company to prepare its life as a public company. Jeffrey Fu: We always advise our clients to start establishing a stronger internal control system even before the company goes public. As part of the auditors responsibilities during the client s IPO process besides the audit we carry out on the company s financial statements we also issue a management letter in which we evaluate the company s internal controls and provide our findings of the company s internal control deficiencies, which are classified into different categories as material weakness, significant deficiency and deficiency. The underwriters always want to review this letter issued by us and they also work together with the US legal counsel to add in appropriate language in the risk factor section of the prospectus, which will be reviewed by the SEC and the investors when the prospectus becomes public information. Once the company becomes a public company listed in the US stock market, it will need to immediately improve and enhance its internal control procedures and systems, especially those related to financial reporting, and these will be subject to audit very soon after the IPO. Therefore a solid internal control system is very important from many aspects. Is it fair to say that private equity firms could do more to help pre-ipo companies set up good corporate governance and internal controls? T Zhang: I agree with Leiming. For Chinese companies, there are two types of businesses: state-owned enterprises and familycontrolled businesses, which have quite different and perhaps even opposite corporate governance problems. Ideally, we would like to invest in almost perfect companies that have adopted international best practices and have been audited by the big four, but in most cases the companies don t meet that standard. We have to understand that growing companies have very different corporate governance and controls, because the costs of that can be high for a small company. As they grow bigger, it s natural for them to be very eager to improve their management, but sometimes they have to set their priorities. If you look at the business, especially a familyowned business, capacity expansion is usually the main priority. When we come in, the first thing we put in place is usually financial planning to help them grow at a more manageable speed. That s where we talk to the company and spend a lot of time helping them improve their corporate governance. That s not always easy because as companies ascend they become more confident about how they became successful and can sometimes get stuck with their own corporate culture and their own way of doing business. It is always difficult to make changes and go to the next step. What are the corporate governance standards for foreign private issuers in the US? Richard Wei

4 JPM Shanghai Roundtable reprint.qxd 12/7/09 10:56 AM Page 4 DEPOSITARY RECEIPTS ROUNDTABLE Shan: Not necessarily. It s a fine balance because sometimes it s very costly. As a company grows you want to move the requirements down the road, but not way beyond the minimum requirements. It s common for most Chinese companies and most Asian companies in fact to only start doing full audits and hiring CFOs just before they go public. It would be rather costly to do it sooner than that. While we re talking about pre-ipo companies, Jonathan perhaps you could share some of your experience? Jonathan Zhang Chen: Under the rules of Nasdaq and the New York Stock Exchange, foreign companies can be exempted from some of the corporate governance requirements of these stock exchanges if they follow their home country requirements. Most of the Chinese non-soe companies listing in the US are incorporated in the Cayman Islands, where corporate governance requirements are not as robust as those in the US. For example, under the exemption granted to foreign private issuers, you don t need the majority of the board to be independent, but we often advise companies going to IPO that it s best to follow best practice in corporate governance even if they are technically exempted. Presumably, Sally, corporate governance standards have some bearing on market valuation? So do you recommend companies to go beyond the minimum requirements? Once a company has decided that it s confident to go forward, the next stage is to take the company on a roadshow. How do you prepare for that? Richard Wei: For the roadshow you really need to work with your bankers to scrub your story and distil your investment thesis down to something that s manageable because you have probably 40 minutes of meeting time and you need to leave time for Q&A. You also need to be prepared to address negative questions that may arise, which builds credibility with investors if you seem surprised by a question it can make them uncomfortable and question if you really know what s going on in the company. Shan: Asian clients sometimes don t pay enough attention to the roadshow process or the after-ipo investor communication, but it s something global investors care about. RIchard Li PICTURE CREDIT: AFP Shan: If they don t comply with the basic requirements we don t advise the company to go public. The companies we take public will at least meet the minimum requirement. What could add value is to have more relevant staff focusing on this as a public company, on the audit front, on the legal front and on the independent committee front, to show public investors you have a transparent company. That will help bring a premium valuation for the company. Jonathan Zhang: When considering an IPO, the first question you should ask yourself is: Are we ready? A lot of companies are not. Given the current market changes, investors are very selective in what companies they invest in, so owners and management should focus even more on the business fundamentals. You need a validated corporate strategy, a solid growth strategy and a solid management team. Once you become public, credibility is number one, so the founders or the owners should really focus on that before they decide whether to kick off an IPO: Can we deliver what we promise? To achieve higher valuation, normally management or owners would over-promise on lots of things and not consider the consequence if they fail to deliver, so investors have to educate the owners and management team. When we start thinking about IPO preparation, the most common question I get from senior management members is: Do you want revenue or profit? My answer is We re going out to sell a growth story, so we want the top line. But the E in P/E is for earnings, so we need bottom line as well. Most of the time people would say: This is hard and we can t do that. In this case, you should really ask yourself: Am I ready? Is your fundamental business giving you 200% confidence you can deliver what you promised for the next year and, most importantly, the next two quarters? If your answer is Not sure or No, you d better wait! Private equity investors can help to construct the best management team suitable for the company using their network and experience and recruit future potential board members as business or financial advisers as early as possible. These people should be industry leaders, successful businessmen and experts in their respective fields, not rubber stamps. The companies will benefit a lot. Once the company goes out for an IPO, with a strong board, solid and reputable management team, and successful operating and financial track record plus the right timing, you will have a much greater chance to achieve higher valuation at IPO.

5 Sally Shan They want transparency, they want to see you, so they can truly believe what you re telling them about the future. A good management team and a good roadshow really set the stage for what type of public company you re going to be. J Zhang: In my experience, there s normally not enough time allocated to the Q&A part, particularly for owners who cannot speak English fluently and are not experienced with Western investors. In that case, the management team really needs to focus on the Q&A preparation to really get everyone prepared on presentation and interview skills, and how to address tough and challenging questions. As an owner of a company or a founder, they don t get challenged that often in their normal life, but during a roadshow you face all kinds of investors and sometimes they intentionally challenge you to see how you handle pressure. Also, some owners or management have the habit to answer questions too fully. They might take 10 minutes or even more. We have to get all the key questions organised and compressed into one or two minutes. That s very important because during a roadshow time flies very fast. Stick with the key messages and highlights you want the investors to remember after meeting with you. Moving on to the IPO itself, what are the preparations for listing day? Wei: The listing day is not as big of a deal as you would think. The hard work is in the preparation of the regulatory filing and the deal roadshow. Listing day is the end of the roadshow and you know the offering has been priced, so you should just relax and enjoy yourself, though of course there will be media attention so you have to make sure you re prepared for that and that you re working with an IR firm that is used to handling financial media. You should make sure you re prepped on the publication, the reporter, the types of questions they may ask you and how to bridge sensitive questions. You also have to work with legal counsel to make sure you don t say anything that s not in the prospectus. But other than that, listing day is a day to enjoy. Leiming, is listing day enjoyable for the legal counsel too? Chen: As lawyers we get very nervous on listing day when the client wants publicity. The SEC has fairly strict rules in terms of what constitutes an offer in the course of an IPO. But, on the other hand, having healthy media exposure helps the company to raise its profile; so it s sometimes very tricky to strike a balance. We usually ask the IR firms to provide us with the plan for media exposure and a list of anticipated questions and we work together to prepare a set of answers to those questions to make sure the media exposure activities and what the representatives of the company will say complies with SEC rules. What we fear most is spontaneous Q&A, which is very hard to control. It s an exciting day and you start talking about things and get carried away and say things that aren t in the prospectus or, more dangerously, people interpret what you say in ways that are not consistent with what you mean. Those are the obvious dangers. Turning to depositary receipts, how effective are DRs when raising capital outside the home market? Are there any types of companies that lend themselves to foreign investors and depositary receipt programmes? Wei: Companies need to think about where they want to raise capital and which investor base they want to go after. If you re a tech company, you need to ask: Do I want to be in the US where I have a lot of investors who can understand my story, or do I want to be in Singapore or Hong Kong where the investor perspective could be different? Once you make that decision, the rest follows. Chen: A lot of Asian companies go public in the US and at one point or another they think about coming back to an Asia stock exchange; so having depositary receipts gives you the flexibility of one day listing the underlying shares in Hong Kong or elsewhere in Asia. Kenneth Tse: An ADR is constructed to be marketed, to trade and to settle in fundamentally the same manner as any other US stock, so in that sense it is on a level playing field in competing for attention from the US investor community. At the end of the day, it s about the fundamentals of the company and how much effort the company management puts into communicating their equity story to investors. Those who have been through an IPO journey realise that an IPO is not the endgame it s just the end of a certain phase and the beginning of a new phase of attracting new investors and capital. A DR programme is not a decision itself, but the decision is where do you want to list your shares? Once the decision is made that your company can benefit by listing in the US market there s no question that an ADR is the best instrument to achieve that. Li: For a company listed in Hong Kong, Leiming Chen

6 DEPOSITARY RECEIPTS ROUNDTABLE when its peer group is listed in the US, it may consider Level I ADR to get some exposure in the US market, then probably upgrade to Level III later on. Tse: Yes, Level I would be a good starting point to explore what it would be like to have an ADR programme traded in the US because it has a lower requirement in terms of Sarbanes-Oxley, SEC disclosure and reporting requirements, and so on. It can broaden the company s shareholder base as well as generate incremental demand for shares underlying the ADRs. Once we re at the next stage, in the post-ipo environment, how do companies best manage their communications with investors? Wei: It s a long-term commitment. After listing you need to maintain a two-way dialogue with your shareholders and make your top executives available to meet with them. For the top executives, they have to be willing to meet with the bigger shareholders and to communicate the equity story to them on a regular basis. You also want to engage an IR firm to conduct perception studies to see what investors concerns are regarding your company. J Zhang: You want to be as transparent as possible, but you also don t want to give out everything, so there s a balance about how much information you should disclose to the public. The IPO preparation is normally the time when you set the tone for what operating and financial metrics you re going to disclose going forward. The management team should spend efforts during the IPO preparation to work with underwriters and sell side analysts to study your peers and best practices and define the metrics. That s very important. Fu: Financial reporting is even more important now than it was in the good days when every single company s share price was going up. At that point investors were quite happy and may not have spent too much time reviewing your financial statements or earnings release information, but it s in the bad days when investors get upset about the share price and that is when investors need more care and better service from the company they invested in, which certainly means more work for the CFO and the company. You need to tell investors what happened, what s happening, what you re going to do to manage your business and improve your performance. It s never enough to say: My revenue dropped 20% because the market wasn t good. The investor may expect the company to provide what I call sufficient information and disclosure. By providing high quality business and financial information to investors and sharing the company s plan and actions to improve your performance, you are building a long-term trust with the investors that will ultimately help you manage your share price and investor relationships this is the key aspect of responsibility for a CFO. J Zhang: One point to add. It s good practice if you always try to under-promise and over-deliver. Sometimes it requires real guts to develop realistic guidance particularly when business is not doing well and you have to guide down. It s not an easy thing to do when you re under pressure from your boss and the board. However, as a CFO sometimes you have to manage that pressure. You guide properly and then you deliver within the guidance. Credibility is more important than anything else in the public market. Wei: Just on a tangential point, companies have a tendency to do roadshows when times are good and then when times are not good, they stay home. You want to stay away from that model investors want to see you when times are good as well as when times are bad. You need to tell investors what caused the problem and what you re doing to address it. That s important too. When you deliver on that you will create credibility with investors, which helps you in the long run. Chen: From a legal and regulatory perspective, a public company should timely disclose material developments and trends in its business whether it s operational or financial developments. Sometimes a material development might take two months to mature, so it s quite tricky to know at what stage to disclose and what to say about it. You don t want to conceal a material development, but you also don t Jeffrey Fu want to mislead the market. So often lawyers and accountants work closely with the company to decide when and how to disclose. In the context of delivering bad news, you don t want to get into a situation where regulators could say you didn t disclose in a timely way. So working closely with advisers after an IPO is pretty critical. How do companies determine if a development is material in nature? Chen: There is no black-and-white definition of materiality. The guidance given by the SEC and courts is whether a development would have an impact on a reasonable investor s decision to invest in your company. That standard is not easy to interpret, so you would have to step into the investor s shoes and ask if you would buy or sell the stock in the company if you learned about the development. If you know a development that could be material, you should think ahead about disclosure. In a case where significant related-party transactions are involved, to give one example, you have to think about how you re going to explain the value of the transaction to your company and why you want to do it. You also want to think about whether an independent committee should be established to assess the fairness of the transaction and whether the committee should retain independent financial advisers and lawyers to make sure that the transaction is done properly. If you PICTURE CREDIT: AFP

7 proactively address these types of issues you pre-empt a lot of questions and challenges investors may have. How do you go about attracting new investors after an IPO? Wei: You need to do shareholder identification and investor targeting so you know who your shareholders are and which potential new investors management should meet with. These steps and frequent nondeal roadshows are essential for attracting the appropriate mix of investors. Li: Our company has just announced that we re going to have a strategic new investor, which is globally recognised by the market as a very high-profile investor with a good reputation. This may ease the hang-over on the release of the lock-up of pre-ipo investors. For the long-term development of the company, an IPO is not the end of the financing. Going forward you have to keep in touch with current shareholders but also reach out to new investors that could become your long-term partners. And what could we expect to see in the public equity markets? T Zhang: My short answer is that it will grow dramatically. If you look at the development of private equity in China, it has been dominated by international private equity funds and since last year we have seen the establishment of new renminbi private equity funds and I m sure these will grow in Kenneth Tse the next few years and slowly US dollar funds will probably become much smaller in this market, but even today there is still a great shortage of experienced private equity professionals. Tse: It s always difficult to predict the trend of IPOs, particularly in times of market volatility, but the recent uptick in SEC filing activity reflects that a number of companies are waiting to raise funds in the market and certain PEs would like to monetise their investments or deleverage their balance sheets. After this crisis, the market will take a bit of time to achieve some stability and investors will need some confidence-building before the IPO market is healthy again. That said, Asia is on the brink of a long-term market boom. We have a seen a lot of activity in China already, but as someone overseeing DRs in Asia I see activity in other parts of the region as well. India is a very good example. That market isn t just dependent on government-stimulated activity India has a sizeable domestic consumption market that will lend support to the equities market, so we ll be seeing DR issuance across quite a broad range of industries in India. Taiwan is also a market not to ignore. Two sectors we should watch: the IT sector, which is a proxy for the Taiwan market, and also the finance industry because recapitalisation could probably drive some DR activity going forward. Finally, Kenneth, how will the balance between public and private equity change in the future? Tse: There has always been a shifting balance between these two sources of capital. Human beings make progress and economies grow because there are people who are willing to take risks. When a company starts out it has a higher risk profile and its funding can only be met by investors with a greater appetite for risk. But the higher growth of a start-up can also bring higher returns, which compensates those investors who are willing to take that level of risk. But as a start-up company moves towards late stage, its risk profile also changes, so it s time for private equity to exit their investment and move on to new Tim Zhang investments that meet their risk appetite. Accordingly, we must trust that the market will achieve an appropriate equilibrium between private and public equity. IN CONCLUSION, A FEW CLEAR MESSAGES ARE EVIDENT: Good candidates for an IPO should have strong business fundamentals they should be market leaders with experienced management and a sound growth strategy. Although it is possible to be too early in adopting costly corporate governance and internal controls measures, it is never too early to start preparing for the higher standards required of a public company. Private equity can play an important role in helping a start-up company to make this transition, including advice and financing for value-creating M&A. An IPO is not an end in itself and should be appreciated as a single step in a longterm strategy focused on attracting the right balance of investors in a business. Once listed, public companies need to deliver what they promise and be proactive in communicating with shareholders, whether in good times or bad. Finally, companies that fail to adopt best practices may prosper in the short term but will be the first to suffer when market conditions force investors to be more selective in their portfolio construction.

8 To find out more about J.P. Morgan's leadership, expertise, and how we can help you, please contact: Kenneth Tse Managing Director, Asia Pacific Depositary Receipts, J.P. Morgan Tel: (852)