China’s Tightened Grip on Tech Share Sales Rattles Investors

China’s regulatory crackdown on tech companies selling shares abroad is rattling private equity investors that have made fortunes from public offerings in the U.S. by Chinese companies over the past two decades.

The authorities’ overwhelming response to ride-hailing giant Didi’s initial public offering (IPO) in the U.S. “is an important node,” said a manager at a U.S. dollar-dominated investment fund. Private equity investors will feel the pinch as the government’s actions are likely to hit a pause button on Chinese companies’ rush for American IPOs, the person said.

“I don’t think there will be any (Chinese) companies to go this year” for U.S. share sales, he said.

Chinese regulators revealed revised regulations July 10 requiring that any Chinese company holding the personal information of 1 million or more users would have to seek a government cybersecurity review before a foreign flotation. Such companies should provide “IPO materials to be filed” with the Cybersecurity Review Office, a newly empowered, interdepartmental bureau, according to the draft regulation.

The new rules mean almost all Chinese internet companies that are eligible to go public in the U.S. will come under review, which would last 45 business days to three months.

The regulatory move, reflecting concerns over data security cited by Chinese authorities, followed Didi Global Inc.’s decision to push ahead with a New York listing in the face of objections from regulators. Days after Didi’s debut, regulators initiated an investigation and ordered the removal of Didi apps. The clampdown sent shockwaves to the capital market and triggered selloffs of U.S.-traded Chinese companies.

Several companies preparing to raise capital in the U.S. put their plans on hold, while some institutional investors have quietly reduced holdings of foreign-traded China stocks, said Liao Ming, founding partner at Prospect Avenue Capital, a tech startup private equity firm based in Greenwich, Connecticut.

Overseas institutional investors that have been the major participants in China-focused private equity and venture capital funds are recalibrating their China strategies following the Didi case, an industry source said. U.S. dollar-dominated private equity and venture capital funds are the main backers of China’s rising tech upstarts.

“The recent regulatory moves targeting overseas listings will further add concerns over global investors,” a source said.

For private equity investors betting on Chinese tech companies, the best option is probably waiting, one industry source said. “Now is the time of intensifying storm,” the person said.

Shifting strategy

Despite the imminent effects, Liao predicted that the Didi incident’s influence on China-focused dollar funds will be limited in the long run. That is partly because many global investors have shifted their focus away from the online consumer service providers that are affected most by the new cybersecurity review rules.

“Major dollar-dominated venture capital funds have shifted away from internet service companies with direct-to-consumer fulfillment,” one private equity investor said. Instead, investors have been chasing emerging sectors that have state strategic support such as high tech, artificial intelligence and cloud, the person said.

Compared with yuan funds, dollar funds often have longer investment horizons and can wait seven to 10 years before exiting through a startup’s public share sale, making them more resilient to regulatory risks and market fluctuation, experts said.

Since the second quarter of 2020, China’s private equity funds have accelerated fundraising as the market revives, increasing their liquidity. In the first quarter this year, 873 private equity and venture capital funds, including 19 dollar funds, raised a total of 223.8 billion yuan ($34.5 billion), up 6.3% from the same period a year ago, according to research institution Zero2IPO.

Investment is also speeding up. In the first quarter, 2,110 investment deals were made, up 33.3% from a year ago. Disclosed value of the deals totaled 257.4 billion yuan, up 89.3% year-on-year. Information technology, biotech, health care, semiconductors and electronics are the most popular targets of investors, accounting for 60% of total investment, according to Zero2IPO.

Market sources said that while many yuan funds stick to investments in traditional tech sectors, dollar funds are more actively exploring new opportunities, especially in the so-called new consumption sector, where companies combine new business formats with consumer services and goods.

Earlier this month, fast-food chain Hefu-Noodle said it raised 800 million yuan from investors include CMC Capital, ZWC Partners, Tencent and Longfor Capital. In the same month, bakery chain Tiger Attitude Chartered Pastry Bank raised $50 million in a financing round led by GGV Capital and Tiger Global Management.

Contact reporter Han Wei (weihan@caixin.com) and editor Bob Simison (bobsimison@caixin.com)

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