Discounts and Investment Performance of Chinese PIPEs

Abstract

The Chinese private investment in public equity (PIPE) market offers a unique window into China’s capital markets and their regulatory environment and culture. Chinese PIPEs share many common features with their counterparts in other countries, such as price discounts relative to their publicly traded sister share prices, lock-ups creating illiquidity and incentive distortions, concentrated positions with a few buyers, and a preferred financing tool for companies without other options. But some characteristics of this market are specific to China. Since the regulatory guidelines were introduced in 2006, PIPEs have become the main and, most of the time, the only available equity financing option for listed companies. PIPE applications with the China Securities Regulatory Commission (CSRC) are often approved within a few months, whereas IPOs and seasoned equity offerings can take a couple of years to approve (if they’re ever approved at all) and are subject to much tougher requirements. In recent years, the IPO option was simply closed most of the time by the CSRC. As a result, PIPE offerings are, on average, more than 35% of the total shares outstanding and can be as high as 90% or more. PIPE deals are distributed across industries, much like the structure of the Chinese economy: PIPE financing is dominated by firms in industries that have experienced the worst capacity overexpansion, with relatively few deals done in industries that have minimal overcapacity issues. The authors analyze determinants of PIPE discounts, post-PIPE financial performance changes, and post-PIPE excess stock returns. They discuss and design optimal investment strategies to take advantage of PIPE offerings in China and backtest the strategies. The authors conclude that on a risk-adjusted basis, Chinese PIPEs present attractive opportunities.