Successful IPO prompts renewed interest in US listings

When Chinese online gaming company Changyou.com started the marketing for a US initial public offering in mid-March, at a time of very volatile markets, it was by no means a guaranteed success. Several US IPOs that had launched since the beginning of the year had been forced to withdraw before pricing due to the volatile market environment and a lack of investor interest, and when Changyou decided to have a go, only one US company had managed to complete a listing in 2009. The two most recent Chinese listings in the US, which took place in late July and early August last year before the financial crisis began in earnest, had also both been significantly downsized after launch as investors were nervous about committing money to untested newcomers. That nervousness resulted in several deals being either delayed or pulled in the US markets last summer.

Looking at Changyou specifically, some commentators noted that the company derives more than 90% of its revenues from a single game, Tian Long Ba Bu. While this is presently the third most popular online game in China there is no guarantee that the company will be able to repeat that success with its future products, they argued.

However, Changyou persevered and when the deal closed on April 1 it had attracted orders for 15 times the number of American depositary shares on offer, which allowed it to fix the price at the top of the range at $16 for a total deal size of $138 million (including the 15% overallotment option which was exercised four days after the debut). And, as if to prove that this success was no short-lived April fool's day joke, the share price surged 25% when the company started trading the following day. Since then, it has continued to edge higher, finishing at $38.70 on Monday -- up more than 140% from the IPO price -- after reaching a record close of $39.34 on June 4. While these gains have come amid a rebound in the general market, Changyou.com has significantly outperformed the 18.7% rise in the Nasdaq Composite index in the same period.

Having demonstrated that investors were prepared to put some of their cash to work again, Changyou.com also opened the door for a series of other IPOs in the US markets in April and May. So far, all six of these have been by US companies, although Chinese specialty chemicals manufacturer Chemspec International yesterday started the roadshow for a small IPO of about $65 million through Citi and Credit Suisse.

So what made Changyou succeed when several other listing candidates failed? And what will other companies have to offer to receive the same favourable response from investors?

Jason Cox, head of ECM for Asia-Pacific at Bank of America-Merrill Lynch, which acted as joint bookrunner for Changyou's IPO together with Credit Suisse, argues that the basic start for any successful IPO has to be a quality product. However, Changyou also benefitted from the fact that it was being spun off from Sohu.com, which is already listed in the US.

"The parent has a long relationship and great track record with investors and over the past many quarters it has met or exceeded expectations, which laid a great groundwork for the spinoff," Cox said in an interview with FinanceAsia. "The gaming business has always been a key piece of Sohu's business and revenues, so research reports have focused on it and investors have watched it develop and grow over the years. Because of that there is already a familiarity. That was pretty important in terms of getting immediate credibility and immediate momentum for the deal."

Tellingly, the only US IPO to be completed in the first quarter this year -- the $828 million listing of Mead Johnson Nutrition in February -- was in a very similar situation. The producer of baby milk formula, which was also brought to market by BoA-Merrill Lynch alongside Citi, Credit Suisse, J.P. Morgan and Morgan Stanley, was a spin-off from Bristol-Myers Squibb, a US-listed drug manufacturer that also has a strong track record both in terms of earnings and share price performance. And even though it was sold into a market that was still highly volatile, Mead Johnson's share price did head higher after listing and, by the time Changyou priced its deal, Mead Johnson was trading 16% above its IPO price.

Another key factor that helped ensure the success of the Changyou deal, according to Cox, was that the bookrunners were able to make sure that investors understood from the beginning that the deal would get done, in spite of the market volatility and the drought of new issuance success. That way they knew that it would be worth their while to take a closer look at the company and to do the research.

"By the time [the roadshow] hit the US we were covered and to be able to go out with that message was very important as the whole issue of 'do I spend time on this, is this thing real?' goes away immediately. You still had to get people comfortable with that in that market, I think."

Market activity since Changyou's debut has shown that there is still demand for companies that do not have the reputation of a well-known parent to rely on to catch investors' attention. However, we are still quite far from the days when investors were buying basically anything put before them in the anticipation of sharp gains on day one.

"I think similar to Changyou, even if it isn't a spin-off situation, a solid track record and a history of earnings stability and performance is critical," Cox said. "But investors are very willing to buy into proven stories and the amount of liquidity that we saw for [Changyou] was something that we hadn't seen for quite a while. Basically, cash levels were at an all time high, investors were actively looking for opportunities and were very willing to invest - but it had to be high-quality. Risk tolerance is obviously nowhere near where it was in the previous two years, but liquidity is even greater than before the financial crisis."

Cox has a good perspective on the issue since Merrill Lynch has been involved in the past six Chinese IPOs in the US, including all three deals that were completed in 2008. The overall market sentiment has clearly improved since the most recent two -- China Distance Education Holdings and China Mass Media International Advertising -- came to market in July/August but like other investment bankers Cox is well aware that a continuing rally in the secondary markets doesn't automatically mean that primary market issuance will meet with the same enthusiasm. For one, new listings do typically equal little known or "untested" companies that need more than a promising business plan to attract attention

"Changyou was a huge success, but it doesn't bring us back to the market of 2007 (a record year for Chinese IPOs in the US with 26 new listings). I think it demonstrates that the liquidity is there, the ability to complete is there and the successful aftermarket is there, but all of that is still dependent on an appropriate valuation," he noted.

To read the rest of this interview, please go to page 2.