Viewpoint: Behind Renren's US stock market venture

Beijing internet cafe Renren is the latest in a slew of Chinese internet companies to list in the US

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Chinese social networking site Renren is hoping to replicate the blowout success of another Chinese internet company, Qihoo 360 Technology, which sold $176m worth of shares in March on the Nasdaq, the US technology stock market.

Qihoo's share price shot up 136% on its first day of trading.

However, Renren's offering on the New York Stock Exchange has been controversial.

According to its latest Securities Exchange Commission (SEC) filing, Renren had approximately 117 million activated users as of 31 March, a figure on which the valuation for the company has been widely based.

It subsequently clarified that only 31 million of these used its services at least once a month, leading to claims that it may have misled investors, and that the valuation for the company should be revised downwards.

In addition, Renren adjusted down the figures for its monthly unique log-in users for the first quarter of 2011, from seven million to five million.

Despite this, the company increased the price range for its planned US stock market flotation by 30%, from an initial $9-11 per US-traded share to $12-14.

Increased scrutiny

Renren's offering comes in the wake of the "reverse merger" scandal in the US, that has reportedly prompted an investigation by the SEC into the accounting practices of up to 350 Chinese companies with US stock market listings.

In 2011 alone, more than a dozen class action suits are said to have been launched there against Chinese companies.

Some 370 Chinese firms have obtained stock market listings in the US since 2004 via "reverse merger" transactions.

Unlike Renren, Qihoo or 21Vianet - which recently floated in a $195m listing in the US - these companies obtained their US stock market listings by acquiring shell or "blank cheque" companies that were already listed, thereby avoiding the regulatory strictures of a formal Initial Public Offering (IPO) on the stock market.

Of these transactions, 159 took place between January 2007 and the end of March 2010, according to the Office of Research and Analysis of the Public Company Accounting Oversight Board (PCAOB) in the US.

A number of these companies, including Fujian-based China MediaExpress Holdings, a company listed on Nasdaq that specialises in advertising on buses, are said to have significantly overstated their accounts and misled the market.

It is notable that much of these developments appear to be taking place in the US, which has stringent disclosure requirements for listed companies, including through the extensive and demanding Sarbanes-Oxley legislation.

Accounting issues

The reality is that the powers of non-Chinese regulatory authorities are often limited when it comes to Chinese companies that are not also listed in their home country.

The PCAOB highlighted in a recent news release that, because of the position taken by authorities in China, it is currently prevented from conducting inspections of the US-related audit work of accountancy firms in the country and, in some cases, in Hong Kong.

In the risk factors included in the prospectus that US regulators require it to produce for its IPO, Renren stated that it had identified "one material weakness and one significant deficiency in its internal control over financial reporting" in the course of preparing its consolidated financial statements.

Renren's stock market flotation, which is particularly notable because of its size, somewhat recalls the listing on the Nasdaq exchange of Shanda Games Limited, an online game developer, operator and publisher from China that was spun-off from its parent in a $1bn IPO in September 2009.

In that transaction, early investor enthusiasm for the deal prompted the parent company and the banks arranging Shanda Games' flotation to increase the number of shares being offered by more than 30%, while also pricing them at the top end of investors' expectations.

But Shanda Games' US shares subsequently fell 14% upon start of trading - and were still trading 40% below the IPO price on 29 April.

While some share sales have been pulled or postponed over the last few weeks, the pipeline of expected new deals remains very full, with China very much at the forefront.

However, recent events will no doubt call for an increased focus on commercial, financial and legal due diligence - for the benefit of investors and all market participants.

In the meantime, Renren and its advisers may want to keep the history books in mind.

Philippe Espinasse worked as an investment banker in the US, Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Links to external sites are for information only and do not constitute endorsement. Always obtain independent, professional advice for your own particular situation.

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