The Risks and Benefits of Foreign IPOs in the U.S.

I’ve been curious as to what risks or benefits an influx of foreign IPOs means for U.S. markets and companies.  Chinese IPOs have been a major focus this year as a number of Chinese companies, including Alibaba, Weibo, iQiyi.com and JD.com, are expected to list in the U.S. again this year since the delisting of 20 Chinese companies in 2011 and fears around accounting fraud and country risk.  In the past two years, only 11 Chinese companies have listed on U.S. exchanges.  Foreign companies see the opportunity to obtain access to a more liquid U.S. market by listing in the U.S. and are able to do so without having turned a profit.  Additionally, there is strong interest in the dual-class ownership structure allowed in the U.S., which enables a company to issue more than one class of shares with different voting rights.  As such, ownership in the company may be the same for individuals but the voting rights would be uneven, typically granting more voting rights to the management team (e.g. Google and Facebook structures).

My initial thoughts were that there could be a long-term negative impact from the growing number of foreign IPOs in the US because of the looser corporate-governance standards to list and post-IPO underperformance as a result of country risk and pre-IPO overvaluations fueled by increased investor risk tolerance and information asymmetry.  My research has both confirmed these concerns/risks and also suggested a more positive outcome.

Below is a summary of my research.

Shrinking stock market

Since 1990, the US stock market has been shrinking in number of publicly listed companies, from a peak of 8823 in 1997 down to ~5000 in 2012 (see chart below).  There is fear that a continued shrinking stock market would limit the number of companies that investors could buy shares in, impacting the value of the stock market and inflating stock prices.  This phenomenon could also cause investors to increase their investment activity abroad on foreign stock exchanges, decreasing trade volume in U.S. exchanges.  Foreign IPOs would help increase the supply of equities on U.S. stock exchanges and bring in more foreign investors, helping boost the U.S. IPO market (liquidity, encourage domestic ipo activity, increase ipo fee activity, etc.).

Number of listed companies on US exchanges

Data on Initial Public Offerings: Foreign IPOs in the U.S., 1988-2012 here.

Transparency

Country risk and asymmetric information along with fears of financial fraud are the main investor concerns for foreign companies.  Studies have revealed that foreign IPOs on average underprice more than matched domestic IPOs and this can be attributed to the above listed uncertainties.  Underpricing occurs when the offer price of an IPO is set at a significant discount to its first-day close price.  Recall the Baidu IPO which was offered at $27 per share and closed at $122.5 on the first day of trading, giving a first-day return of 353.85%.  Based on a study conducted on Chinese firms in the U.S. between 1993 – 2010, it was found that these firms generally underperform the benchmark and industry peers in the post-IPO period of 3 years.  There is a general belief that IPO firms typically experience a significant underperformance relative to their benchmarks in the subsequent 3 to 5 years after issuance.  This suggests that asymmetric information is both driving down initial pricing and causing underpricing.

Delistings

Transparency has been a top priority with a number of firms having delisted due to discovered accounting fraud.  Other reasons include stock underperformance below the exchange performance requirements or failure to comply with financial reporting requirements.  As mentioned above, there were a number of Chinese firms that delisted in 2011 because of financial fraud.  Delisting of companies not only increases distrust of foreign firms, but also results in investor losses as ownership of stock in the company doesn’t change while stock prices further decline as a result of the delisting.  Additionally, delisting would exacerbate the already shrinking stock market by reducing the supply of equities and increasing the perceived risk of listing on that exchange by future potential issuers.

Fear of a repeat of the 2011 Chinese firm delistings and lingering fears of financial fraud has resulted in an increased emphasis of transparency by foreign firms and compliance to U.S. financial reporting standards.  Strict enforcement of rules to improve transparency and compliance to these standards by foreign firms would help create a healthy IPO market and encourage more foreign firms to list on U.S. exchanges.

Ownership Structures

Investors are also cautious of complex ownership structures that allow management to retain more voting rights and allow for too much decision-making power.  These structures are difficult to understand and hinder communication of decisions between the shareholders and management (even more opaque with foreign firms).  The long-term performance of firms with these structures will depend on the success of management’s decision-making abilities to ensure trust among its shareholders, but changes in management will also create instant concern of future decisions among shareholders.  The long term implications of these structures are uncertain but some studies have shown that ownership arrangements like dual-class structures have not historically performed better than arrangements where voting rights are equal for all shares (Paul Gompers, Joy Ishii and Andrew Metrick conducted a study of American firms with different ownership structures between1994 to 2002).

 

I think increased foreign listings on U.S. exchanges are a positive sign for the U.S. as foreign companies identify a healthy and trustworthy market in the U.S., but whether the long-term effects are positive or negative will rely on transparency and the long-term performance of these foreign companies.

 

 

Some Thoughts on Online Education in China

I don’t think online education can or will replace the prestige of attendance at an established university in China or abroad, but I do believe it will complement it.  I had previously thought online education would allow for individuals who could not afford to study abroad to gain access to the resources provided at those foreign universities; however, I have found that Chinese students who study abroad are not evaluated on the content studied abroad but rather their experience.  Also, I have found that Chinese students are motivated to study abroad for 2 main reasons, which do not include access to foreign content: (1) It is a way to avoid the College National Exam / local university pressure and (2) younger students are able to enhance and practice their English (English is a school subject in China and is a full separate section on the College National Exam).  Additionally, this past October, a group of top Chinese universities partnered to launch their own MOOC and learning portal (similar to edX launched by Harvard, MIT and Berkeley).  Given these reason, I don’t think the online education opportunity is in traditional/higher education.

As China transitions from its manufacturing and export-dependent economy to a services and skills-based economy, it will require a more skilled workforce to meet those market demands, suggesting the need for increased vocational education opportunities.  That vocational education has been historically perceived as a low-status education compared to academic-based education (theory over practice belief), suggests that there is a strong divide between the two and students are unable to easily gain access to both.  This traditional ideology naturally encourages students to pursue an academic-based education, creating a workforce that is over-educated but under-skilled.  Additionally, given the competitive job market in China right now (~16% of the record ~7 million Chinese university graduates last year were unemployed), there is increased value in additional learning/training for individuals.  Finally, the need for innovation is necessary for China to maintain its growth, supply jobs and become a knowledge economy, and to fuel that innovation will require access to content beyond school borders and local resources.  This may be where the online education opportunity lies.

Of course, the challenge lies in Chinese government intervention and facilitation of online education.  So far, there are few foreign online education companies that have been able to successfully expand into China, with the exception of Coursera as of the end of last year, in which it partnered with an internet site to launch on that site.  And local companies will struggle to compete with the government/university-backed online offerings (especially if they start to offer not only academic courses but vocational/technical trainings) as they will find it difficult to compete for online enrollment of students and brand themselves as a credible learning site.  I think a company that is focused on offering courses and resources and building a community around a certain subject (become the go-to online destination to learn coding or personal finance or a language), such as Codecademy, will thrive given the current Chinese learning environment.

I’m Lovin’ It: Going Global by Going Local

The end of standardization has been realized for many years now, and it is even more apparent today as companies compete to break into international markets.  We are seeing this with ecommerce companies, sharing services, fashion houses, pharmaceutical companies and a host of other businesses.  Achieving international market growth is not easy and involves constant development of product, brand and distribution strategy as well as awareness of the government’s role in the country and the country’s policies and plans.

By evaluating McDonald’s we can learn effective strategies on how to “think global, act local”.  Over the years, McDonald’s has continued to innovate its menu and adapt its go-to market system, allowing it to maintain its leading global presence, retain its customers and uphold its reputation as the “Golden Arches”.  Many companies are able to break into a new country or environment quickly but fail to tailor their products and services to the needs and demands of its local customers.  Localization must be applied at every level of the business to achieve successful international market growth.

A comparison of the different McDonald’s website by country shows us the importance of brand consistency, language, design and variation of product offerings to accommodate local market conditions.

United States

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China

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France

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Japan

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Most noticeable is the use of color to develop brand recognition and connect with local customers.  The golden arches are displayed in the upper left corner of each of its websites and yellow is a commonly used color across all the sites.  However, notice the McDonald’s French and German websites have replaced the iconic red background with green.  This color change in 2009 was intended to aggressively communicate a more eco-friendly image to help the company connect with a pro “green” customer base in Europe.  In this instance, color was a driver to reflect shared values between the business and its customers, suggesting that the original red and yellow logo colors were not well received in Europe and some separation from the U.S. home company image was necessary.

At a NYC Hacker Growth Event I attended last November, a former LinkedIn employee shared his experiences with launching LinkedIn abroad and how they came across the language factor.  They found that using the local language (initially launched in English) on the website for that country led to increased engagement.  Yes, this sounds obvious but many companies have failed to do this and just think how challenging it will be for young companies with blogs to accurately translate their posts across their different websites (God forbid a grammatically incorrect and Babblefish translation!).

Language is the medium of culture, allowing a group of individuals to share their knowledge, beliefs, values, attitudes, politics and religion.  And because culture is largely tied to identity and influences our interactions (human-human and human-product interaction), decision-making and interests, language is key when building brand equity abroad.  As my best friend Erica Baba beautifully summarized:

“If we look at culture on an individual basis, we can see the impact of one’s cultural ideologies and values on the way one lives and carries himself or herself.  Everywhere we go, we bring with us our culture.  You see, there are things we all choose to do or ways we choose to be because of the cultures we identify with and what they mean to us.”

Allowing an individual to visit a website in his or her own language gives the individual a sense of ownership of the site (most basic form of personalization), allows the individual to easily navigate the pages and explore features, and adds content to the products offered.  As a result, the individual is more likely to return and a community is more easily formed, which is crucial for marketplaces as they expand abroad.

Beyond cross-cultural design and language, and equally as important, are localized products, services and payment options.  Product adaptation and innovation enhance a company’s product offerings because it is tailored to local preferences and culture.  For example, McDonald’s in India does not have beef or pork on its menu (a friend of mine found this out when trying to order a beef burger there…).  And did you know that once a year in China, McDonald’s offers the Prosperity Burger in celebration of Chinese New Year?  McDonald’s has also recently launched a new “rice based” menu in China this past year and The McCamembert, a burger with the French Camembert cheese, in France.  The geographic variations to its menus demonstrate McDonald’s sensitivity and adaptability to local cultures and preferences.

The McCamembert burger from McDonald's. mcdonalds-new-rice-based-menu-for-china mcdonalds-mcarabia-egypt-1 McD taro pie

Check out a few more menu options outside the U.S. here.

Product inventions aren’t always successes (Some of the stuff Taco Bell has introduced is total crap!) but more often than not they resonate with the local consumer.  Product variations should also account for demographics, infrastructure and local trends (e.g. the international car market is particularly sensitive to age group, lifestyle and roads when designing and selling cars to a region).

In addition to menu innovation, McDonald’s has also continued to reinvent its space.  The McCafe was introduced in Europe to adopt the European café lifestyle, capitalize on the growing coffee trend at the time and offer customers a new breakfast option.  And just this past November, Starbucks introduced a new store concept in its Beijing store that was inspired by China’s one-child policy atmosphere and aimed to create a hub for the number of young people near the location.

From the product and service to the product packaging to the company website, the brand is continuously being built and communicated.  The consumers’ knowledge, impression and experience with the product or service will determine the viability and sustainability of the business.

Localized payment methods can best be examined with Flipkart, India’s first billion-dollar internet startup, and Amazon.  Both Flipkart and Amazon offer Cash on Delivery (COD)—the individual pays for the good upon delivery in cash.  According to an article from May 2013, there are less than 20 million credit cards in circulation in India, representing a penetration rate of about 1.7% among the country’s 1.2 billion population.  Additionally, approximately 70% of Flipkart’s transactions are currently completed using COD.  This phenomenon is largely tied to Indian culture, which maintains a leery attitude towards non-cash transactions because of its intangible nature (the physical exchange of cash or gold is symbolic in Indian culture) and perceived lack of security and transparency.  I believe the following excerpt from a research paper titled “Facilitating Global E-Commerce: A Comparison of Consumers’ Willingness to Disclose Personal Information Online in the U.S. and in India” also helps explain some of the resistance to credit adoption:

 “In India, because of its collectivistic culture, consumers may be more willing to extend and preserve their relationship with an organization because it is seen as part of an extended community… Consequently, their desire to maintain the relationship is realized through sharing of personal information.”

Flipkart achieved fast adoption and significant growth in India because it offered services and payment methods that revolved around India’s transaction preferences.  In one year, the company increased its customer base by more than ten times from 0.2 million to 2.08 million as well as increased its website visits from 40 million to 102 million.  Amazon was quick to observe this and prepared to tap the attractive Indian ecommerce market, and since launching Amazon.in, it is also offering COD (although COD is currently only available for Amazon fulfilled products).  Despite COD being the more expensive payment method for the company, Amazon is offering this payment option because it realizes user acquisition would not be possible without adapting to local methods of transaction in India.

Finally, awareness of the local government and legal regulations is extremely necessary as a company looks to expand beyond its domestic borders.  There is significant operating risk from a government that is unsupportive of foreign businesses and that highly regulates marketing activities and distribution channels.  Such is the case in India and China, in which the government becomes a priority customer to the firm.

Of course, this is easier said than done and it will take time.  Localization will require not only an immense amount of research and capital at entry, but also throughout the existence of the business abroad as trends, values, beliefs, attitudes, politics, etc. in a country are ever-evolving.  Remember, quick growth is not always good growth.

globalization