The sky is the limit, but only for so long

As the freeze on listings is lifted, confidence returns to market, leaving experts cautiously optimistic

Over the past year, with impressive equity returns and investor confidence sky high, many firms have made initial public offerings in the US. In particular, the fortunes of Chinese companies have changed more than any other firms in a short time.

In 2012, US-listed Chinese companies began to delist in large numbers because of concerns about accounting irregularities. But confidence has returned, and large Chinese firms such as the online travel site Qunar, the Twitter-like microblogging service Weibo and the online shopping sites Jumei and JD.com have listed in the US.

This change in fortunes is perhaps best illustrated by VIPShop Holdings, which listed on the New York Stock Exchange in 2012. At the time, the listing was disappointing, priced at $6.50, compared with the $8.50-$10.50 range. However, in just over two years, VIPShop is trading near $200. While this is largely due to improving investor confidence in Chinese equities, another factor is investors' interest in the Chinese online shopping industry. During the past year, most of these firms have turned in stellar performances, particularly as the industry's market leader, Alibaba, prepares to list in New York.

Its IPO will make it one of the largest firms listed in the US and, given the size of its earnings and revenues, investor appetite for online shopping equities will continue to grow.

In the splurge on IPOs in the US, investors have attached huge valuations to many firms. A recent example is GoPro, the mini high-definition camera maker, which adventurers use to film themselves in activities such as jumping out of aircraft or off cliffs. In the technology industry there is a shift toward wearable technology, and investors have taken advantage of the GoPro IPO to push it to the current price of $41.58, giving the company a market capitalization of $5.14 billion at the time of writing.

This shows a general appetite on Wall Street for technology IPOs, and investors are snapping up companies that describe themselves as being associated with "wearable technology", "cloud", "big data" or "Chinese online shopping".

But given that in the first quarter of this year there were more IPOs than in any first quarter since 2000, it would be logical for investors to have an air of trepidation about such high valuations. Should the market lose its seemingly insatiable appetite for IPOs, high-tech firms will be among the first to be sold. This is because their valuations, more than most, are based on hype and expectation rather than on fundamental growth and earnings.

Chinese firms would also be sold because they tend to be domestically focused. If investors want to reduce risk from their portfolio, it is natural to keep hold of the companies they understand best. Given that it can be difficult to understand domestic Chinese trends if you are not based in China, foreign investors are likely to sell.

Should appetite wane, Chinese tech firms would lose an important source of funding for their development and expansion. The venture capital industry in China is not well developed, and such investors tend to have a short time frame before they want a return on their capital. Likewise, it is becoming more and more difficult for Chinese firms to list on domestic stock markets. While a year-long freeze on IPOs that stretched from 2012 to 2013 has been lifted, stringent regulations are still in place. In January, an anti-cancer pharmaceutical firm had to shelve its proposed 790 million yuan ($127 million) IPO on the ChiNext board because the proposed issuance was too big.

In the long run, the ability to list in the US will be a strong driving force for Chinese firms to continue their growth and development. Not only do US equity markets offer a much larger investor base for Chinese firms, but it also publicizes the strength of the Chinese economy to the rest of the world.

Recently, mergers and acquisitions activity in China has been at a high, led by Alibaba and two other tech companies, Baidu and Tencent. Baidu recently sold $1 billion of notes so it can buy mobile technology firms, as a response to the success of Tencent's WeChat platform. Yet we are seeing more and more acquisitions from smaller companies, such as VIPShop, which recently bought the cosmetics retailer LeFeng. Acquisitions are now the best way for Chinese firms to develop their market share in online shopping, and the funding from US investors is integral to this strategy.

I think that by next year, the IPO market will have begun to stutter, as investors realize that the sky-high valuations are not sustainable. In the meantime, if Chinese firms can continue to monetize more aspects of their operations and continue to grow earnings, then investor confidence will remain high.