US markets become IPO venue of choice for non-US firms

December 2013 | EXPERT BRIEFING | CAPITAL MARKETS

financierworldwide.com

When China’s e-commerce giant Alibaba – with a valuation that may make it the world’s third largest internet company behind Google and Amazon –decided to go public, Hong Kong was its natural first choice, according to the company. However, the company’s IPO, projected at over $10bn, is reportedly now likely to occur in New York after Alibaba abandoned Hong Kong in a dispute over internal governance and shareholder rights, though details are not yet settled.

For a decade following the passage of Sarbanes-Oxley in 2002, Wall Street watched as a growing number of non-US firms fled American capital markets or avoided them in the first place. As a prominent example, German blue chips Allianz, BASF, Bayer, Daimler, Deutsche Telekom and E.ON had de-listed from the NYSE by 2010, leaving only four major firms from the EU’s largest economy. Today, a variety of factors, including flexibility in corporate governance (such as the dual-class voting structure) and eased public offering requirements for foreign firms are leading international companies to stage a comeback in US listings. As New York Stock Exchange CEO, Duncan Niederauer, noted in his August 2013 article, ‘The U.S. IPO Resurgence’, 46 percent of all IPO capital raised around the globe in 2013 has taken place in the United States, 20 percent in Asia-Pacific and 17 percent in Europe.

During discussions with the Hong Kong Stock Exchange (HKEx), Alibaba’s leaders proposed that a small group of ‘partners’ hand-picked by company founders would nominate director candidates. This approach was apparently too similar to issuing dual classes of shares, something viewed as inconsistent with that exchange’s rules mandating equal treatment for all shareholders.

Alibaba,with an 80 percent market share of online shopping in China, is not the first prominent issuer to look elsewhere after first considering Hong Kong. The general prohibition on companies with dual-class shares in the former British colony resulted in UK ‘football’ (translation: soccer) club Manchester United – reported by Forbes to be the most valuable sports team on earth in 2011 – deciding to list on the NYSE last year. Similarly, the London Stock Exchange, Europe’s leading bourse, also rejects the dual-class voting structure, though exchanges in Germany, Italy and Switzerland, as well as the Toronto Stock Exchange, permit it.

Under such a structure, investors purchase shares of publicly traded equity (frequently Class A), while founders or family interests retain control over the company’s board of directors through a more powerful class of shares (frequently Class B). In the average dual-class company, Class B generally outvotes Class A by a ratio of 10:1.

Two or more classes of shares are frequently seen among tech companies, where founders wish to ensure their original strategy and culture survive the markets’ short-term earnings focus. Some of the most prominent internet IPOs have featured issuers with dual-tier equity, including Facebook, Google, Zynga, Yelp, Zillow, LinkedIn and Orbitz (at the time of its IPO). Many media and publishing companies have adopted this approach, as has Warren Buffett’s Berkshire Hathaway.

It is not clear whether Alibaba will pursue two tiers of shares in a potential New York listing. Its original structure permitting management control of board nominations would be atypical in US markets, while issuing dual-class shares might approximate the intent of granting the power to set long-term direction to a core of insiders, as many internet companies have sought. In October, the company announced that both the NYSE and NASDAQ had confirmed they would accept Alibaba’s proposed ‘partnership’ approach, according to reports in the New York Times and Wall Street Journal.

In contrast to some international venues, dual-class companies are free to list on the NYSE and NASDAQ. Both exchanges have also set a policy that voting rights of existing holders of publicly traded common stock cannot be ‘disparately’ reduced through any corporate action or issuance. The exchanges reveal the pragmatism underlying much of US market regulation, stating that interpretations of their voting rights policies will be flexible as “the capital markets and the circumstances and needs of [listed companies] change over time”. Indeed, foreign issuers listing on NYSE or NASDAQ may follow home jurisdiction rules, with a few limited exceptions, so long as they disclose how their corporate governance differs from that of US companies.

To facilitate overseas businesses’ access to American capital markets, Congress and the SEC have put in place numerous accommodations, including exemption from quarterly reporting (and quarterly assessment of changes in internal financial controls under SOX), in-depth compensation discussion and analysis and the filing of proxy solicitations. US law permits foreign firms to confidentially submit initial registration statements if the issuer, among other things, is (or will concurrently be) listed on an international securities exchange – or is an ‘Emerging Growth Company’ under the JOBS Act – and to prepare financials in accordance with International Financial Reporting Standards rather than US GAAP. Additionally, such foreign companies are not required to comply with Regulation FD, which restricts selective corporate disclosure, and their directors and officers are immune from ‘short swing’ profits liability under Section 16 of the Securities Exchange Act of 1934.

A public offering in the US provides international companies what is arguably a best-in-class market standard that garners them a deep pool of sophisticated investor and investment bank analyst attention they may not receive elsewhere and unparalleled visibility for their brands. Many would agree that, while no system is immune to improvement, US formal laws and regulation (including SEC enforcement), informal scrutiny by powerful insurers and pension funds (and corporate watchdogs like ISS) and robust shareholder litigation offer a combination promoting both long-term capital formation and investor protection and continues to attract market entrants from every corner of the globe.

While some of the hottest IPOs in recent years have adopted the practice of dual classes, certain critics remain. Representative of the latter view is the Council of Institutional Investors, which in 2012 urged an end to new listings of dual-class stock companies. In any case, the provocative insights of HKEx Chief Executive Charles Li may help explain why the dual-class structure is more widely accepted by US rather than Asian markets. Li points to the American institutional investor base and vigorous shareholder litigation as offering “deterrent forces that can offset the negative impact of the different weight in share rights”. In the end, as Li notes, investors will include a discount for the apparent reduction in control featured by Class A shares in the long term market price. Given the freedom to adopt the approach when listing on the leading US exchanges, many issuers (and their underwriters) have banked on such a strategy to finance young companies (or those in certain sectors) with skilled founders driven to carry forward a winning vision.

Brian Korn is of counsel and David Russo is an associate at Pepper Hamilton LLP. Mr Korn can be contacted on +1 (212) 808 2754 or by email: kornb@pepperlaw.com. Mr Russo can be contacted on +1 (212) 808 2714 or by email: russod@pepperlaw.com.

Brian Korn and David Russo

Pepper Hamilton LLP