JD.com (NASDAQ:JD), the largest direct retailer in China, plans to follow Alibaba's (NYSE:BABA) lead with a secondary stock listing in Hong Kong, according to Reuters. JD could list its shares as early as June and raise up to $3 billion, making it Hong Kong's biggest IPO of the year.
JD has appointed Bank of America, UBS, and Hong Kong-based CLSA to oversee the deal. Bank of America and UBS also led JD's IPO on the NASDAQ in 2014. Let's examine the proposed offering, what it reveals about JD's ownership structure, and whether or not investors should be concerned.
What do JD.com's U.S. investors actually own?
Many Chinese companies have gone public in the U.S. for two reasons: better liquidity and less rigid rules regarding profitability. However, China bans direct foreign investments in certain sectors, including internet and education companies.
To sidestep that rule, many Chinese companies set up holding companies in the Cayman Islands. These companies, known as variable interest entities (VIE), are owned by Chinese nationals and own stakes in the actual underlying companies. So when investors bought ADR (American Depositary Receipts) in JD, Alibaba, and other Chinese tech giants, they actually bought equivalent stakes in these holding companies.
Therefore, U.S. investors don't actually have any direct voting rights in the underlying Chinese company. But that wouldn't matter for JD, because its founder and CEO Richard Liu -- who owns about 15% of the company -- still controls nearly 80% of voting power via a dual-class share structure.
What will JD.com's Hong Kong investors own?
Hong Kong-based investors would also buy shares of JD's Cayman Islands-based VIE, since the region is administered separately from mainland China. Hong Kong-listed stocks shouldn't be confused with China's proposed CDRs (Chinese Depositary Receipts), which would allow mainland investors to own shares of their top tech companies.
JD currently has a market cap of just over $60 billion, so a $3 billion offering would dilute its shares by just under 5%. That's significantly higher than Alibaba's HK offering, which diluted its existing shares by less than 3%.
However, JD's stock currently trades at less than one times this year's revenue, so the dilution won't significantly inflate its valuations. Moreover, JD recently approved a $2 billion buyback plan, good for the next 24 months, which could offset that dilution.
The Hong Kong listing looks like a safety net
It might seem odd for JD to raise $3 billion in a new IPO in Hong Kong, only to potentially repurchase $2 billion in shares to offset the dilution. However, it makes sense against the backdrop of escalating trade tensions between the U.S. and China.
Several lawmakers have asked American exchanges to delist Chinese companies that don't open their books up to U.S. auditors. The Trump Administration recently blocked federal pension funds from buying additional shares of Chinese companies, and several Chinese companies are being targeted by prolific short sellers.
If the situation deteriorates further, JD and other U.S.-listed Chinese companies could be forced to delist their shares. If that happens, Chinese companies could be forced to the OTC (over the counter) markets, which have much less liquidity than the major exchanges.
That worst-case scenario probably won't ever happen, since other major companies -- including Tencent, Walmart, and Alphabet's Google -- own large stakes in JD and would likely protest its delisting. Nonetheless, it's prudent for JD and Alibaba to remain listed in a neutral market like Hong Kong, which gives them easy access to investor capital without relying too heavily on the U.S. market.
The key takeaways
JD's planned Hong Kong listing, like Alibaba's, shouldn't meaningfully affect U.S. investors. However, it clearly indicates Chinese companies want to spread their bets out in case the trade and tech war between the U.S. and China evolves into a new Cold War.