Didi is the largest ride-sharing company in China that recently went public in the United States. But a huge decision by China combined with the nature of U.S. listings has created a terrible event for current investors. Last week, I outlined real challenges for a very popular IPO. Ride-hailing company Didi Chuxing, which went public in late June, had the largest IPO for a Chinese firm since Alibaba Group (BABA) a few years ago. But just days after going public, shares fell from the sky.
| | | | | | The Real Problem with Chinese "Listed" Stocks |
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| Dear Reader,
Last week, I outlined real challenges for a very popular IPO.
Ride-hailing company Didi Chuxing, which went public in late June, had the largest IPO for a Chinese firm since Alibaba Group (BABA) a few years ago. But just days after going public, shares fell from the sky.
The reason: The China Administration of Cyberspace (CAC), an extended arm of the Chinese government, banned all smartphone app stores in the country from continuing to offer the Didi app.
For a nation that has 377 million Didi customers, China will prohibit any new members until a cybersecurity assessment is complete.
A Fundamental Problem
The problem that Didi - or its investors - has is a fundamental one.
It is a problem that all Chinese companies listed in the U.S. face.
The problem also has a name: Variable Interest Entity or VIE for short.
If you haven't heard of it, you're in good company.
When a foreign company takes its shares public in the U.S., those shares are typically deposited with a U.S. bank and then traded during U.S. trading hours as American Depositary Receipts, or ADRs, through U.S. broker-dealers. ADRs simplify investing in foreign securities because the depositary bank manages all custody, currency, and local tax matters.
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| | | This approach is not the case for Chinese companies listed in the United States.There are no shares that have been deposited as a pledge with a U.S. bank. Investors in Chinese stocks do not buy a stake in a company.When you buy a share of Alibaba, Tencent, or Didi, for that matter, you are instead buying a promise of contractual obligations that almost perfectly mimics owning a real share.With just one exception: as the owner of such a promise - you can't call yourself a shareholder - you have no voting rights.But most private investors - judging by the hustle and bustle at the buffet table - overlook that anyway.This promise is called Variable Interest Entity. So VIEs allow Chinese companies to access foreign capital that would not be available because of government regulations on foreign ownership of specific industries and assets.
What if it's all gone?
Now we have seen in the past week that the Chinese government can come up with crazy things. Now, what if it occurred to it, given the legal gray area in which VIEs operate, to just ban them completely?Then not just a few billion, but several trillion U.S. dollars of market capitalization in the USA and Europe - where Chinese shares are also traded in the form of VIEs - would be wiped out without further ado.Is this a foolish thought experiment? Looking at the escalating Sino-American tensions, one seriously wonders if it's just a thought experiment in the long run.The recently deceased U.S. Secretary of Defense, Donald Rumsfeld, spoke of the "unknown unknowns" in this context. You should seriously consider whether you want such a risk in your portfolio.I'll be back with a few better ways to invest abroad on Thursday.Enjoy your day, |
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| | | Dr. Gregor Bauer
Chief Analyst, European Markets |
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