Nuts. China Is Hoarding Unicorns and Breeding Squirrels

(Bloomberg Gadfly) -- At the Bloomberg Ideas conference in San Francisco this week, I had the honor of sitting on a vibrant panel to discuss if capital markets in the U.S. support innovation.

The day after, I can't help lamenting about China.

Sure, Asia's largest economy is peppered with unicorns. Three of the world's five most-valued startups reside there. Since 2017, another 27 companies have reached a $1 billion valuation at their latest funding round, bringing the country's total unicorn count to 64, CB Insights data show.

Nuts. China Is Hoarding Unicorns and Breeding Squirrels

But this isn't something to be proud of. If anything, it's a sign entrepreneurs and venture capitalists have few exit options.

Finding those opportunities is critical. China is planning to bring home some U.S.-listed tech giants using CDRs, or Chinese depository receipts. Alibaba Group Holding Ltd. and JD.com Inc. will be among the first to issue CDRs, Caixin reported earlier this week, citing unidentified people familiar with the matter.

But how will CDRs help unicorns?

Securities regulations in China require that any firm planning to list on the main board must have generated at least 30 million yuan ($4.7 million) in net profit for three consecutive years. That's a tall order: The world's most valuable unicorn, Uber Technologies Inc., remains in the red.

Even if startups are already making money, the rules are such they'll probably think twice before applying.

The China Securities Regulatory Commission said last month that applicants denied an IPO have to operate for at least three more years before even considering "going public through restructuring means" -- code for backdoor listing via a shell company. Unlike the U.S., where companies can debut so long as their financial disclosures are in order, China's system is opaque and arbitrary.

Three Squirrels Inc., a food distributor that sells nuts on Alibaba's e-commerce site and is backed by IDG Technology Venture Investments, is a good example.

In October, the CSRC questioned Three Squirrels' special rights arrangements even though such clauses with shareholders, which typically include anti-dilution, mandatory redemption and veto rights, are commonplace. In December, the Wuhu, Anhui province-based company, whose earnings went from 9 million yuan in 2015 to 236 million yuan in 2016, shelved its IPO plans.

Nuts. China Is Hoarding Unicorns and Breeding Squirrels

Similarly, one would imagine that if a company was listed in New York for almost a decade, it should be good enough for China. Yet Mindray Medical International Ltd., a medical devices maker that was taken private in a $2 billion deal in 2015, also withdrew its application last month.

According to Caixin, the CSRC modified IPO rules in November requiring that companies count their goodwill toward total intangible assets. Now, companies seeking to list on the main board may not have intangible assets exceeding 20 percent of the total. Mindray has a large amount of goodwill due to a series of overseas acquisitions.

Don't count on a sympathetic ear from state-owned banks, either.

360 Security Technology Inc., formerly known as Qihoo 360 Technologies Co., won approval for a high-profile backdoor listing late last year. But the $7.6 billion transaction wasn't all smooth sailing. Earlier this month, 360 Securities revealed it had pledged 48.7 percent of its shares, now worth about $25 billion, to China Merchants Bank Co. as collateral for a $3 billion loan in support of its privatization.

Speakers at the Bloomberg Ideas conference worried that funding can be tight for startups that don't reside in Silicon Valley. They should try visiting China. It's no place for unicorns, or squirrels.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

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