August 9, 2022

DealBook: Investor Hunger for Foreign Tech Stocks Overrides Risk

Harry Campbell

It doesn’t hurt to be known as the Google of Russia.

Shares of Yandex, the Russian search engine company, shot up more than 55 percent in their Nasdaq market debut last week. The stock’s rise illustrates investors’ voracious appetite for emerging-market investments and Internet initial public offerings. But Yandex is also a sign of another trend: investors are willing to ignore the special risks associated with foreign Internet companies in their hunger for riches.

Yandex raised $1.3 billion in an I.P.O that valued the company at about $11 billion. This is a heady number for a company that operates only in Russia, Europe’s second-largest internet market, and has limited prospects outside that country. Yandex has about 65 percent of the Russian search market, but Google lurks there as well and has 22 percent of the market., Russia’s biggest Internet company, is another potential competitor.

Still, Yandex’s valuation is not as bubbly as other tech companies’. The Russian company is valued at about 23 times 2010 revenue of about $440 million. Compare this with LinkedIn, which is valued at 35 times revenue and has a market capitalization of about $8.5 billion.

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Yandex is even conservatively valued compared with another foreign tech company, Renren. Called the Facebook of China, Renren made its debut in early May on the New York Stock Exchange, raising about $855 million. Renren’s stock is trading at about $13 a share, a bit below its initial offering price of $14 a share.

At this price, Renren is valued at $5 billion, a high valuation for a company with 2010 revenue of only $76.5 million and operating income of $17.3 million. Renren, valued at 65 times revenue, only has about 20 million to 30 million users a month and is far from China’s dominant Internet player. Competition also looms for Renren with rumors circulating of a partnership between Baidu and Facebook.

Yet the danger is not only that these companies may be part of a bubble, but that they have risks particular to foreign companies.

Take Renren. It is not even technically a Chinese company. Instead, it is incorporated in the Cayman Islands. This island location is in part because foreign ownership of Chinese companies is limited by the Chinese government. Because of these legal restrictions, buyers of Renren stock may be startled to know that Renren does not even own its major subsidiary, the operator of its social networking site.

Instead, the wife of Reren’s chief executive and founder owns 99 percent of the subsidiary, and Renren has only a contractual relationship with its primary business. Renren contends that this is effectively the same since it entitles Renren to operate the company and receive all of the economic benefits of the operation.

This may be true, and such arrangements are not uncommon when Chinese companies list abroad. But this is not the same as full ownership. China does not have a strong rule of law, and enforcing contractual rights in courts can be quite difficult. Chinese regulators could interfere and unwind this contractual relationship, or Renren’s chief executive could decide to take advantage of this relationship.

What if Renren’s chief executive and his wife were to divorce? With $5 billion at stake, people may not act in the most ethical manner. Yahoo can ably attest to these problems. It is in a fierce dispute with its Chinese partner, the Alibaba Group, a company Yahoo owns 43 percent of. Yahoo accuses Alibaba of illegally transferring Alibaba’s most important subsidiary, Alipay, using China’s murky and under-enforced laws to shield these actions.

There are also questions of accounting fraud. The chairman of Renren’s audit committee, Derek Palaschuk, resigned in the weeks before Renren’s I.P.O. because of accusations of fraud at another Chinese company listed on the New York Stock Exchange, Longtop Financial Technologies, where he was the chief financial officer. Accounting fraud is a serious problem among Chinese companies, as Floyd Norris of The New York Times recently noted in writing about Longtop. Shares of Longtop are now worthless.

If American shareholders are defrauded, their remedies are limited because any lawsuit would be required to be brought in China. The hapless owners of houses with Chinese drywall can tell you what a difficult barrier this creates.

These problems are not limited to China and take form in other emerging markets. Yandex is incorporated in the Netherlands. This likely reflects the need for clear rules to govern the company, something lacking in China and Russia. And in Russia, the principal fear is not fraud, although it is certainly possible, but government interference or nationalization.

Yandex specifically cites in its I.P.O. prospectus the risk involved with the coming Russian presidential election and states that Yandex may be subject “to aggressive application of contradictory or ambiguous laws or regulations, or to politically motivated actions.” In other words, the rule of law is anything but certain in Russia.

Given these risks, I wonder why these technology I.P.O.’s are seeking to list in the United States over other countries. It may be that we have the most robust capital markets, and this is primary attraction. There is also a darker explanation. We also have investors and day traders who invest with the herd and a media that too often drives “enthusiastic” investing. There may be something about the American market that allows bubbles to build. Foreign internet companies are simply coming here to feed on the phenomenon.

Even if this is too dark an explanation, investors should be put on notice that not all technology investments are the same. Foreign investments in particular carry much more risk, which American investors do not appear to appreciate.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.

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