What China's IPO crisis means for PE investors

An effort from the China Securities Regulatory Commission (CSRC) to clear the backlog of applications for initial public offering (IPOs) has focused attention on whether international and domestic private equity sponsors can rely on IPO markets as the primary avenue to exit from their investments. This backlog exists due to an increasing supply of companies that meet the criteria for a domestic listing, and that have as shareholders one or more private equity investors seeking liquidity. The backlog also exists because of different features of the regulatory approval processes for domestic IPOs that have limited the number of IPOs that can take place during a given period. The CSRC imposed a moratorium on new IPO approvals beginning in October 2012 and earlier this year purged a number of financially weaker applicants from the queue due to a December 2012 issuance by the CSRC of the Circular on Properly Conducting a Special Check on the 2012 Financial Reports of IPO Companies《关于做好首次公开发行股票公司2012年度财务报告专项检查工作的通知》. The Circular imposed additional requirements on issuers and sponsors to provide certain self-inspection reports to the regulatory authority as a condition to any approval. Recent news reports suggest that the CSRC may have completed this exercise – after purging far fewer applicants than many observers had expected – and might lift the moratorium in the near future.

Regardless of when the moratorium may end, it has highlighted to private equity sponsors that the domestic Chinese IPO window is capable of being closed suddenly and for extended periods of time by regulators. It also shows that the timing and success of exits through a domestic IPO may be more uncertain than previously thought. The moratorium has drawn attention to the persistent nature of the huge backlog of IPO applicants in China and the impact this backlog has on the ability to achieve exits through the domestic IPO markets. The problem of a clogged IPO window is likely only to worsen over time given the imbalance between the large and rapidly growing pool of private equity-backed businesses in China. A sizeable number of these businesses will represent IPO applicants in coming years, and the much smaller number of companies that can realistically expect to conduct a domestic IPO in any given year.