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Once again, facing the crisis of delisting, will Chinese concept stocks experience a "rebirth" this time?

In April of this year, Dolphin Analyst expressed a strong view in the China concept stock review after the 2021 fiscal year, stating that due to the extreme pessimism caused by the Shanghai epidemic and the risk of delisting from US stocks, the stock prices of China concept stocks have fallen below their intrinsic value. They would undergo significant repair, and subsequent developments are broadly consistent with the views of Dolphin Analyst. However, after two quarters, Dolphin Analyst believes that China concept stocks have once again reached a crossroads:

①Valuation: after two quarters of recovery, China concept index (KWEB.US) has rebounded by more than 42% since the bottom on March 15th. Although the current valuation of China concept stocks is still low, it is no longer in an extremely undervalued state that can be "bought without thinking".

②Fundamentals: China concept stocks have basically passed the worst performance bottom of the second quarter (revenue growth). With the easing of competition and regulation, there will be a certain expectation of releasing profits by increasing efficiency. The second half of the year will enter the consumer peak season, and some companies' revenue will also recover after the pandemic.

③Policy: Although the "new foreign listing regulations" passed domestically in April and the preliminary regulatory cooperation agreement signed by China and the United States at the end of August reduced the overall risk of delisting for China concept stocks, today, Hong Kong PwC and mainland BDO were selected as the two accounting firms to prepare for PCAOB's inspection. However, there is still no substantial consensus between China and the United States, and the risk of China concept stocks being delisted has not been completely eliminated. As the final delisting deadline (early 2024) approaches, market concerns will continue to grow.

Therefore, Dolphin Analyst believes that the topic of the US-China government's audit regulator competition and the risk of China concept stock delisting cannot be avoided before judging the investment prospects and cost-effectiveness of China concept stocks. Whether the "sword" of delisting falls or not will greatly affect the future trend of China concept stocks, and panic and risk aversion will overwhelm everything in the short term.

Therefore, this article will still start with the topic of the risk of China concept stock delisting to launch Dolphin Analyst's China concept stock review for the first half of the year.

Friends who are interested in interpreting reports on China concept companies are welcome to add the WeChat account "dolphinR123" to join the investment research group to get the Dolphin Analyst in-depth research report and discuss investment opportunities with investment veterans in real-time.

I. Where will the crisis of China concept stock delisting go?

1. The past and present of the crisis of delisting

Dolphin Analyst has analyzed the evolution of China concept stock regulation issues and delisting crises in detail in the article "The end is near? Talk about the turning point in the risk of China concept stock delisting." published in April, so we will not repeat it here.

Dolphin Analyst mainly reviews the time axis in the figure below, retrospect the multiple rounds of competition launched by the US and Chinese governments over the audit supervision right of companies listed on US stock exchanges, and the delisting crisis caused by it.

When looking at the history of Sino-US negotiations, the core dispute between the regulators publicly is summarized in two points: who should dominate the regulation, and whether the US can freely and completely obtain all kinds of information covered by the audit working papers.

In summary, the risks faced by Chinese concept stocks are: ① if the two sides fail to reach an agreement on audit supervision, Chinese concept companies listed in the United States will be forced to delist from the US stock market after submitting their 23-year annual report (usually in March-April 2024); ② and if the "Holding Foreign Companies Accountable Act" is passed (currently only passed by the Senate, still needs to be passed by the House of Representatives and then signed by the President to take effect), Chinese concept companies will be forced to be delisted after releasing their 23-year annual report (early next year).

Looking at it this way, the countdown to the delisting of Chinese concept stocks is only one and a half years long, and it is short if it is less than half a year. Once Chinese concept stocks are indeed forced to be delisted (or there is a high probability of it), it will inevitably lead to funds escaping at all costs. Therefore, the risks faced by Chinese concepts are still not small, and the remaining time is quite urgent.

From an investment perspective, as long as the delisting risk is not completely resolved, the market's preference for Chinese concept stocks, and even Hong Kong stocks, will be suppressed for a long time, making it difficult for Chinese concept stocks to break through and form trend opportunities unless some companies have extremely strong performance. Otherwise, Chinese concepts as a whole will only have a band rebound opportunity after overselling.

2. The cooperation agreement is only the beginning, and the delisting crisis has not been resolved

Facing the crisis of Chinese concept stock delisting, the two sides suddenly announced the signing of a preliminary agreement on audit supervision cooperation on August 26th, which really boosted the market. The signing of the agreement shows that both parties are willing to communicate and resolve disputes, which slightly reduces the market's worries about the delisting of Chinese concepts. However, from the statements issued by both sides afterwards, it can be seen that there is still no consensus between the two countries on the core dispute. The specific differences between the two sides are:

①On regulatory dominance, although China has made concessions and no longer requires that our regulatory agencies dominate, it still requires that the US conduct supervision with our assistance and participation; while the US requires independent and autonomous supervision, regardless of whether the other party is present.

②On information security, although China generally believes that audit working papers do not involve confidential or sensitive information, according to current regulations, any audit working papers in China cannot be transferred to overseas without regulatory approval, and if they involve sensitive information, it is prohibited from being disclosed to the public without the approval of the competent authority. However, the US requires PCAOB to be able to fully obtain working papers information and retain or transfer relevant documents to the SEC as needed.

Looking at it this way, the preliminary cooperation agreement signed by China and the US on regulatory dominance and information protection reflects the willingness of both China and the US to cooperate and resolve disputes, and provides a framework for future cooperation and negotiations, but **it will take time to truly resolve the dispute over auditing rights and the delisting of Chinese concept stocks. Investors should pay attention to which core signals now?

In the current situation, what are the variables that have the greatest impact on and need the most attention regarding the Chinese concept stock delisting crisis? Dolphin Analyst believes that there are mainly two points:

① Whether the "Holding Foreign Companies Accountable Act (HFCAA)" will be implemented before March next year. In June 2021, the "HFCAA" was passed by the US Senate, but it has not yet been passed by the House of Representatives and officially effective. If it is not implemented, China and the US will have more than a year and a half to negotiate. If the "HFCAA" is implemented, the possibility of Chinese concept stocks being delisted will greatly increase, and in this case, the large-scale sale of Chinese concept stocks for hedging purposes will be a high-probability event.

From a time perspective, if the "HFCAA" is implemented, China and the US need to reach a fundamental consensus before the beginning of next year, which is too urgent and difficult to achieve. Moreover, if the United States really chooses to pass the "HFCAA", it also indicates that the United States either does not have the intention to reach an agreement with China, or wants to force China to make huge concessions through extreme pressure. However, under such circumstances, it is basically impossible for China and the US to reach a consensus.

② The progress of the current preliminary cooperation agreement between China and the US is also a key signal. The Chairman of the US Securities and Exchange Commission stated that the PCAOB personnel will consider visiting China to conduct audit inspections in mid-September, and judge whether Chinese auditing firms can meet the requirements of the "Holding Foreign Companies Accountable Act". If progress is smooth, the US is expected to reach a conclusion before the end of this year. Therefore, whether China and the US can finalize the cooperation agreement in the implementation level at the end of this year and the beginning of next year is also a key signal. If it is successfully implemented, the valuation of Chinese concept stocks will most likely rebound, and long-term foreign capital will also return to Chinese concept stocks.

However, under the background of confrontation and competition between China and the US, it is difficult for China and the US to reach a consensus on regulatory attribution and information security. When the PCAOB conducts audit inspections, it will most likely involve regulatory departments in multiple non-securities systems in China, and cross-departmental communication and coordination are difficult, and the pilot inspections will take time.

Therefore, the most likely baseline scenario in Dolphin Analyst's opinion will be:

(1) The United States will not implement the "Holding Foreign Companies Accountable Act", and the ultimate deadline for the delisting of Chinese concept stocks will still be the beginning of 2024;

(2) China and the US are unlikely (and not urgent) to substantially finalize regulatory cooperation at the end of this year and the beginning of next year, and completely eliminate the risk of delisting. It is most likely that China and the US will continue to be in a "quarrel."

As long as the trend of power struggle between the two sides cannot be reversed, the risk of delisting of Chinese concept stocks will be difficult to completely eliminate. But completely giving up Chinese companies for the US stock market is also a lose-lose situation that harms both parties. The United States has a strong political demand (the midterm elections in the US end in November), and should not force Chinese concept stocks into a dead end.

At the micro level, for different Chinese concept listed companies, it is basically inevitable for state-owned enterprises to delist from the US (a considerable portion has already delisted), and most Chinese private companies should not be forcibly delisted except for a few involving a large amount of sensitive information (e.g., medical, logistics, high-tech industries, etc.), but it may be necessary to study the "possibility of delisting."

二、Are Hong Kong Chinese Concepts a Good Way Out for Chinese Stocks "Retreat"?

1. Which Chinese Companies Have Found Their Way Out?

Although the Dolphin Analyst believes that the full-scale delisting of Chinese stocks from the United States is a low-probability event, if unfortunately it becomes a reality, among the several ways out for Chinese companies, relisting in other markets (Hong Kong, A-shares, Singapore, etc.) is basically the best way out for investors.

Combing all the Chinese stocks covered by Dolphin, according to their previous listings in the American market, they can be divided into four categories:

Hong Kong is the main listing place: including Tencent, Meituan, Xiaomi, and Geely. These companies have ADR trading on the US stock market, but their main trading place is in Hong Kong. Therefore, even if ADR is delisted, the impact on the company's stock price is small.

Hong Kong is used as one of the dual main listing places: Including Li Auto, KE Holdings, Xpeng, and MINISO. Dual primary listing means that the company will be publicly traded again in Hong Kong, and the shares traded will be independent of those traded on the US stock market. Therefore, these companies will not be affected in terms of listing status in Hong Kong after being delisted in the US stock market, but the loss of liquidity in the US stock market will still have an impact on the company's stock price.

Hong Kong is the secondary listing place (secondary listing): including Alibaba, JD.com, NetEase and other companies, the largest number of companies belong to this category. Unlike the dual primary listing, the secondary listing is to trade the shares already listed on other markets in Hong Kong. Therefore, the secondary listing in Hong Kong depends on the listing status of the primary market. If these companies are delisted from the US stock market, they will not be able to continue trading on the Hong Kong stock market and can only be traded in the OTC market, and their stock price will suffer a huge impact.

Not listed in markets outside the US: including Pinduoduo, Boss Zhipin, Vipshop, etc. These companies are not yet ready for a "way out," so after being delisted from the US stock market, only OTC trading and privatization will remain as choices. Once the risk of delisting Chinese stocks tends to increase, these companies will also be hit hard.

2. How difficult is it to return to Hong Kong for relisting?

Although only four of the Chinese assets listed on the US stock market covered by Dolphin have completed a dual listing in the Hong Kong stock market, which means that after other companies are delisted from the US stock market, they will lose the channel of public market trading and will be abandoned by the secondary market funds, the actual situation is not so severe. According to the listing requirements of the Hong Kong Stock Exchange (see below), all other companies covered by Dolphin, except Dingdong Maicai, meet the requirements for a dual primary listing in Hong Kong.

Therefore, under Dolphin's benchmark scenario (i.e. the deadline for the delisting of Chinese stocks is the beginning of 2024), other than Dingdong Maicai, all other companies have sufficient time to complete a dual primary listing in the Hong Kong stock market, maintain their listing status, and reduce the impact of US stock delisting.

How long does it take for Chinese concept stocks to return to Hong Kong for listing, and what is the process? In 2018, Hong Kong Exchanges and Clearing Limited (HKEX) issued new regulations allowing companies with dual-class share structures to list, significantly reducing the difficulty and time required for listing. Depending on the type of listing, the process can be:

  1. Secondary listing in Hong Kong: The process is simple, and the time required is relatively short. Taking Alibaba as an example, it applied for listing on HKEX at the end of 2019, officially announced the issuance documents on November 13, and was listed and traded on HKEX on November 26, with a total elapsed time of only 13 days. In addition, in late July of this year, Alibaba also announced that it plans to add Hong Kong as a primary listing location and is expected to complete the listing process within the year.

  2. Dual-primary listing: The process for dual-primary listing is the same as for initial public offering and is therefore longer. Taking Li Auto as an example, it applied for listing on HKEX at the end of May 2021, announced the issuance documents in June, obtained approval for issuance after HKEX hearing at the end of July, and was listed and traded on HKEX on August 12, with a total elapsed time of nearly two and a half months.

  3. Dual-primary listing (introduction): In addition to the long-standing traditional process, the introduction of issuance (registration only, no financing) also provides a simple and fast way. In May 2021, KE Holdings disclosed the issuance document and was listed and traded on HKEX by May 11, with a total elapsed time of only 6 days.

The main conditions for the introduction of issuance to the market are: the company has no fundraising needs and has been listed on other exchanges, so the company only needs to register the shares it already has for trading on HKEX, thereby shortening the processing time.

Therefore, for Chinese concept stocks that need to raise funds, the time required to return to Hong Kong for listing should be about three months, while companies with no fundraising needs can complete the process within a few weeks. In general, if Chinese concept stocks are delisted from the US stock market, there is ample time for Chinese concept companies to complete the return to Hong Kong process.

3. Is returning to Hong Kong a "panacea"?

Although most Chinese concept stocks covered by Dolphin Analyst have this road to return to Hong Kong, is returning to Hong Kong a perfect solution? Unfortunately, the answer is also negative. Although returning to Hong Kong can maintain the listing status of Chinese concept companies and prevent them from being completely abandoned by secondary funds, the market size and liquidity of Hong Kong stocks are clearly far behind those of US stocks. Just taking the companies covered by Dolphin Analyst as an example, among the Chinese concept stocks listed both in Hong Kong and the US, the average trading volume in the US stock market is 5.2 times that in Hong Kong.

In terms of the total amount, the average weekly trading volume of the main board of HKEX was around US$68.8 billion in the past year, while the total weekly trading amount of the Chinese concept stocks covered by Dolphin Analyst in the US was as high as US$40.6 billion. Considering the current liquidity of HKEX, it is completely unable to bear the liquidity required by Chinese concept stocks.

Therefore, even if Chinese concept stocks all successfully return to Hong Kong once delisted from the US market, due to liquidity considerations or restrictions on the investment region of funds, Chinese concept stocks are still difficult to avoid being partially abandoned. In terms of liquidity discount, the overall valuation of Chinese concept stocks is likely to be lowered.

4. Which Financing Channel Behind the Listing of US Stocks Is More Important?

In addition to triggering capital outflows from the secondary market, the withdrawal of Chinese companies listed in America also means losing the best financing channel of the US capital market. So among the US-listed Chinese companies covered by Dolphin Analyst, who has the most urgent financing needs?

According to our statistics, Missfresh, Bilibili, and iQiyi are currently the companies with the most financing needs. They currently have negative net cash on hand and negative operating cash flow over the past 12 months, meaning that they don't have money and don't have the ability to make money.

In addition, Xpeng and Ctrip may also have certain financing needs. Ctrip has a negative net cash balance but positive operating cash flow; Xpeng has negative cash flow in the past but still has a net cash balance of CNY 138 billion currently.

Dolphin Analyst's Summary of the Risks of Chinese Companies' Withdrawal from the US Market:

① Overall, with the preliminary agreement reached on regulatory cooperation between China and the US to resolve the disputes over regulatory authority and the withdrawal of Chinese companies from the US stock market, the risk of Chinese companies withdrawing from the US market has been further reduced.

② However, the current disagreements between China and the US over regulatory authority and the security of audit work papers are still far from being resolved, and it will take some time to completely remove the risk of Chinese companies' withdrawal from the US market.

③ The most important signals to be concerned about at present are: first, the progress of the cooperation agreement between China and the US, especially the progress made by the US regulatory agency PCAOB in conducting regulatory trials in Hong Kong in recent days; second, whether the US will push for the passage of the Accountability Speed-up Act at the end of this year or early next year. If the former proceeds smoothly, it basically means that the risk of Chinese companies withdrawing from the US market will be eliminated, and the valuation of Chinese companies is expected to recover. But if the latter is passed, the withdrawal of Chinese companies from the US market will be difficult to reverse and basically confirmed, then the Chinese companies will be sold off by investors.

④ Dolphin Analyst thinks that the most likely outcome of the Chinese companies' withdrawal crisis is that the US will not pass the Accountability Speed-up Act and the final deadline for the withdrawal of Chinese companies from the US market will still be the beginning of 2024. At the same time, it is difficult for China and the US to completely remove the risk of withdrawal from the US market by the end of this year or early next year (and there is no urgency), so the ongoing dispute between the two countries is the most likely scenario.

At the micro level, it is almost inevitable for Chinese companies with state-owned backgrounds to withdraw from US stock exchanges. But among private companies, except for a few with lots of sensitive information (such as medical, logistics, high-tech industries, etc.), most companies should not be forced to withdraw from the US stock exchanges but will still be under pressure from the US to withdraw.

⑤ Among the Chinese stocks covered by Dolphin Analyst, all companies except Missfresh have already completed their return to Hong Kong or meets the conditions for returning to Hong Kong. Depending on whether the company needs financing, the process of returning to Hong Kong can take as long as three months (with demand) or as short as a few weeks (without demand). Therefore, the vast majority of Chinese companies have the conditions and sufficient time to complete their return to Hong Kong and avoid the worst-case scenario of losing access to the secondary market trading channel.

⑥ However, the liquidity of the Hong Kong stock market is difficult to fully meet the trading needs of Chinese companies. If Chinese companies are delisted from the US stock exchanges, even if they have already returned to Hong Kong, their valuations will still decrease due to liquidity discounts. And from the perspective of financing channels provided by US stocks, Dingdong, iQiyi and Bilibili are currently the companies with the most financing needs. If they lose their financing channels in the public market, the impact will be more obvious.

Dolphin Analyst's related research in the past:

April 27, 2022 "Alibaba vs. Pinduoduo: After the fight, only coexistence?"

April 22, 2022 "Why are Meituan and JD.com excellent in stock market competition?"

April 13, 2022 "Towards the decline of the cycle, how much value is left for Alibaba and Tencent?"

April 11, 2022 "The deadline is approaching? Talk about the turning point of Chinese concept stocks being delisted"

Risk disclosure and statement for this article: Dolphin Analyst's disclaimer and general disclosure

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