Xiaomi Redmi phone.

China's 84 Questions for Xiaomi Show Hurdles for Tech IPOs

(Bloomberg) -- The collapse of Xiaomi Corp.’s plan to sell stock in mainland China is an example of Beijing’s ambition getting ahead of its reality.

Intransigent regulators, lack of clarity from the central government and a company sticking by its own deadline combined to scuttle the first attempt to sell Chinese depositary receipts, according to people familiar with what happened. That forced Xiaomi to nearly halve what it would raise and has thrown into doubt what was expected to be a conga line of other Chinese tech giants joining exchanges in Shanghai and Shenzhen.

As China seeks to put its stamp on the world as a global power, having homegrown successes go public overseas has been a source of discomfort for Beijing, especially since Alibaba Group Holding Ltd. went to New York in 2014 for the biggest initial public offering ever. The CDR program was meant to fix that, giving local investors a chance to buy into companies whose technology they use every day. But with regulators unwilling to bend on Xiaomi, one of this year’s largest IPOs, the future of other Chinese listings has been called into question.

Xiaomi had planned to raise about $10 billion selling stock in Shanghai and Hong Kong, but that fell apart when it couldn’t adequately answer 84 questions posted online by Chinese regulators and still meet its target for a Hong Kong listing, the people familiar said, asking not to be identified. Officials at the China Securities Regulatory Commission were concerned Xiaomi was pricing its debut too high and that retail individuals, who are the majority of China’s stock market, might get wiped out if things go south, according to one of the people.

Instead Xiaomi and several existing investors are now said to be raising only $4.7 billion from just the former British colony after pricing its IPO at the very bottom of a marketed range. It has said it will revisit CDRs later.

“Adding a China CDR into a long-planned Hong Kong offering at short notice was always going to be a tall order,” said Jason Sung, capital markets partner at law firm Herbert Smith Freehills in Hong Kong.

While Xiaomi was meant to be the first to carry out a simultaneous listing in China and offshore, many other publicly-traded tech companies have said they want to return home, in one form or another. Alibaba, Tencent Holdings Ltd. and Baidu Inc. are just some of the foreign-listed companies that said they were interested in CDRs.

“There is no reason why future offerings can’t incorporate a China CDR though, especially if they plan to meet the needs of the two very different listing regimes from the very start,” Sung said.

But Xiaomi was supposed to be the perfect test case: A tech giant that retail investors would clamor to invest in, and one that had committed to playing by the rules.

Despite assurances from the CSRC that it would support a simultaneous listing in Hong Kong and Shanghai, regulators responded to Xiaomi’s June 7 CDR application with questions about everything from its business model to its lofty valuation

Officials at the regulator received complaints that double standards were being applied to Xiaomi, one of the people familiar said. Xiaomi was seeking a faster approval of its listing and sought exemption from rules requiring the company to be profitable.

The regulator also pushed for the China component to be larger than the funds raised in Hong Kong and argued for lowering valuation targets to the detriment of current Xiaomi shareholders, the people said. Leading up to formally kicking off the IPO, the company’s target valuation has fluctuated between $50 billion and $100 billion.

The CSRC told Xiaomi that the CDR portion had to be cheaper than the stock sold in Hong Kong, one of the people said. That would have given it a better chance of a first-day surge in Shanghai.

“The CSRC would have looked really bad in front of retail investors if Xiaomi’s valuation was touted at $70 billion and then came in at $50 billion, or if the stock fell 30 percent from the outset,” said Smartkarma analyst Travis Lundy. “By kicking it back and letting Hong Kong digest a slice of it first, the CSRC reduces the risk of messing up that first trial.”

Xiaomi declined to comment beyond previous public statements, while the CSRC didn’t respond to faxed requests for comment.

“We’ve done a huge amount of CDR-related work lately,” Xiaomi Chief Financial Officer Chew Shou Zi told reporters this month as the company opened the retail offer. “To ensure a successful CDR issuance, we decided to be listed in Hong Kong first, then do CDRs when time is right. The CSRC agrees and supports this plan.”

Billionaire George Soros and investment firm Hillhouse Capital are seeking to invest in Xiaomi’s Hong Kong IPO, according to people with knowledge of the matter.

Hong Kong and mainland China have very different rules for companies going public. For example, China requires loss-making companies like Xiaomi to forecast profits in the future, which is not the case in Hong Kong. Chinese companies also must disclose board minutes and deal deliberations, and the CSRC insisted that Xiaomi’s prospectus comply with its rules, not Hong Kong’s, according to people familiar with the discussions.

“You have to comply with both regimes and that may mean you have to do more to comply with more onerous requirements in China,” said Martin Rogers, a partner at law firm Davis Polk & Wardwell, who advised the Hong Kong Stock Exchange on setting up the listing framework for depositary receipts, but wasn’t involved in the Xiaomi process.

Xiaomi and its advisers worked furiously on crafting a prospectus for China that could meet the demands of regulators without providing an unfair amount of information to investors in Shanghai, one of the people said. The prospectus also had to be reconciled with the company’s April filing to Hong Kong regulators.

With all these issues to work out, Xiaomi decided it would be difficult to harmonize the process and still meet its intended IPO timeline, the people said. Among its concerns were that any delay would force the Beijing-based company to update all its financial numbers through a large and expensive separate audit. 

On June 18, Xiaomi sent a letter to the CSRC stating that “after due consideration, we would like to complete the global offering first and conduct a CDR offering in mainland China at an appropriate time in the future,” according to Xiaomi’s updated prospectus. 

The failure to reach agreement with Xiaomi has changed timing expectations of the CDR program for one high-ranking executive at a technology company considering a stock listing in China. Getting the program to work and resolving differences between the CSRC and companies will take longer than originally envisioned, said the executive, who asked not to be identified.

For other companies considering CDRs, big questions remain. These include whether the CSRC will issue valuation guidance on their China listings, whether the stock is fungible and if there will be trading quotas. That has bankers, companies and lawyers expecting several more months before a clearer structure emerges. 

In general, the CDR process remains “a mystery box,” said Antony Dapiran, of counsel at law firm Skadden, Arps, Slate, Meagher & Flom, who works on these issues. “There was never a level of detail provided that was particularly clear.” 

(An earlier version of this story corrected the job title in the final paragraph.)

©2018 Bloomberg L.P.