- Didi's shares fell after major government probes were announced into the ride-hailing company just days after its massive IPO in the U.S.
- The company had warned of regulatory scrutiny in its prospectus, including that it had "not obtained the required permits for all cities where we are required to do so."
- "The rules are there, but the internet companies normally ignored these regulations and (venture capital firms) ignored the compliance issues," said Ming Liao, founding partner of Beijing-based Prospect Avenue Capital, which manages $500 million in assets.
BEIJING — For investors in Chinese IPOs like Didi, reading the fine print will become more critical for avoiding losses.
Ride-hailing app Didi — dubbed the "Uber of China" — raised $4.4 billion on Wednesday in the biggest U.S. initial public offering of any Chinese company since Jack Ma's e-commerce giant Alibaba went public in 2014.
Two days later, Didi's shares fell 5.3% after Chinese regulators announced a cybersecurity investigation into the company, suspending new user registrations. Then on Sunday, the agency ordered Chinese app stores to remove Didi's main app over data privacy concerns. Existing customers can still use the ride-hailing app.
While many investors in the U.S. may never use Didi or know much about China's regulatory environment, the company — and other Chinese IPOs — disclosed some warning signs in their prospectuses filed with the U.S. Securities and Exchange Commission ahead of the stock offering.
On the second page of a section titled "Risks Relating to Doing Business in China," Didi said it had two meetings with regulators in April and May, along with industry peers. The company warned that in both cases, it could not ensure that efforts to comply would satisfy regulators.
In addition, Didi said in its prospectus it had "not obtained the required permits for all cities where we are required to do so" and "not all drivers on our platforms have gone through the process to obtain the requisite licenses in each city where we operate."
"The rules are there, but the internet companies normally ignored these regulations and (venture capital firms) ignored the compliance issues," said Ming Liao, founding partner of Beijing-based Prospect Avenue Capital, which manages $500 million in assets. The firm expects a few of its invested companies will list in the U.S. this year.
Before its IPO, Didi was valued at $62 billion as one of the five largest privately held start-ups in the world, according to CB Insights.
Goldman Sachs Asia, Morgan Stanley and J.P. Morgan were among the slew of investment banks that underwrote Didi's IPO, while SoftBank was a major investor, according to a filing.
However, Didi did not disclose all aspects of its businesses in China, such as its finance technology arm.
Increased regulations in the last year
The heightened scrutiny on Didi is the latest move by authorities to tighten regulation in the last 10 months.
Last fall, Alibaba founder Jack Ma gave a speech in Shanghai that served as a wake-up call for authorities, Liao said.
Ma's comments appeared to criticize regulators, and came shortly before the company's fintech affiliate Ant was set to list in Hong Kong and Shanghai in November. Days before the stock offering, Chinese regulators abruptly suspended the IPO, and subsequently fined Alibaba $2.8 billion in an anti-monopoly probe.
"The government realized the internet companies, especially the internet giants (were) becoming too powerful to comply with the regulations," Liao said.
Three days after China announced a cybersecurity probe into Didi, the same agency announced an investigation into businesses held by two Chinese stocks that went public in the U.S. in the last month — Full Truck Alliance and Boss Zhipin, which filed under the name "Kanzhun."
"The regulatory crackdown is one that is not intended to completely curtail profitability for these large companies," Timothy Moe, chief Asia Pacific equity strategist at Goldman Sachs, said Monday on CNBC's "Street Signs Asia."
"We think broadly it's an attempt to update a regulatory framework that is needed in a rapidly changing environment," he said. The investment bank expects stocks affected by regulatory concerns to rise over the next six months.
Risks for investors
Ahead of Full Truck Alliance's IPO, the company disclosed in its prospectus a history of data privacy violations. Boss Zhipin said it could face fines of up to 10,000 yuan ($1,562.50) per office space lease for not registering the agreements as required by Chinese law.
The three companies above also discussed general uncertainty about Chinese government actions, growing scrutiny against monopolistic practices and U.S.-China tensions.
Another risk for investors is that founding executives typically retain a large controlling stake the U.S.-listed Chinese companies.
Didi's two co-founders Will Cheng and Jean Liu hold a combined 58.1% of aggregate voting power. Boss Zhipin's founder Peng Zhao had 76.2% of voting power, and Full Truck Alliance's founder Peter Zhang had 83.4%, filings showed.
While analysts said China's lax regulatory environment allowed start-ups to experiment and grow rapidly, the lack of enforcement has also attracted speculators and permitted business practices that sometimes came at the expense of consumer savings or safe labor conditions.
Meanwhile, differences in regulation and language allowed some Chinese companies to raise money in the U.S. with less scrutiny and investor understanding that an American company might have faced.
Cases of fraud
In 2018, the American documentary "The China Hustle" estimated that pension funds and retirement funds lost at least $14 billion to Chinese stocks that turned out to be frauds.
Last year, revelation that a Nasdaq-listed Luckin Coffee executive fabricated sales worth about $314 million prompted the stock's delisting. Later in the year, the collapse of Danke, a Chinese residential rental business owned by U.S.-listed Phoenix Tree Holdings, also led to its delisting from the New York Stock Exchange.
U.S.-listed Chinese companies often used a listing structure that allowed the stock to exist in a grey zone between the U.S. and China, said Winston Ma, former managing director and head of North America for China Investment Corporation (CIC), a sovereign wealth fund.
Now, both countries are stepping up regulation.
"In the future, similar companies may go through a more prolonged regulatory review process for (an) IPO," Ma said, who is co-author of the book "The Hunt for Unicorns: How Sovereign Funds Are Reshaping Investment in the Digital Economy.
What this could mean for Chinese IPOs
The increased regulatory action will likely slow the rush of Chinese IPOs in the U.S., analysts said.
Chinese companies have clamored to list in New York, often for branding purposes, regardless of U.S.-China tensions. Last year, 30 China-based IPOs in the U.S. raised the most capital since 2014, according to Renaissance Capital.
As recent as late April, about 60 Chinese companies were still planning to go public in the U.S. this year, according to a representative for the New York Stock Exchange. An update wasn't available as of Tuesday.
Each prospectus lists more than 35 points on which the companies "cannot assure" investors of growth and different aspects of business success.