Reverse takeovers

Separated by vast geographic distances, the language barrier and differences in legal systems, many US investors find it difficult to fully evaluate the true worth of companies operating in China. That provides some dishonest Chinese companies with the opportunity to take advantage of US regulatory flaws to cash in on the capital market.

A major way to accomplish that is through reverse takeovers (RTOs), which allow companies to trade on US exchanges even though their operations are situated overseas. The listing process is quicker than a traditional initial public offering and involves less scrutiny of the credibility of a company's financial performance.

A survey by the US Public Company Accounting Oversight Board, which monitors auditors, identified 159 Chinese companies that listed in the US through RTOs from the start of 2007 through to March 2010. That's almost three times the number of Chinese companies that launched normal IPOs in the US over the same period. A Bloomberg index also shows that Chinese RTOs more than tripled between March 2009 and January 2010.

"US investors don't understand China, because they don't use the services of the companies that they are investing in," according to Charles Zhang, chairman of Sohu.com Inc.

He said many US investors believe that most Chinese Internet companies are simply copies of established US companies, and so they often take it for granted that the companies will provide good returns because of China's continued economic prosperity and the nation's ever-expanding number of Internet users.

According to figures from the Nasdaq exchange, during the past 12 months Chinese Internet stocks put up the strongest showing on the first day of their listing with three Chinese shares among the top five highfliers.

"People want to simplify things and have something that's easier to understand and to relate to," said BDA's Duncan. He said there is a tendency for Chinese companies to try to position themselves as "the X of China". "That may be useful in terms of raising capital. But if you live by cloning, maybe you die by cloning," he added.

China story

In fact, US-listed Chinese companies, particularly those with high growth potential, have already proved attractive investments. A good example is Baidu Inc, which is a consistent holding for many American hedge and mutual fund managers, and it has also performed exceptionally well - up nine times over the past two years, compared with Apple Inc's three.

"In the US, the Chinese growth story continues to be a very popular investment theme, and investors are eager to find new ways of accessing China investment themes," said Isaac Souede, chairman and chief executive officer of Permal Group, one of the oldest and largest alternative asset managers in the US.

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According to figures from the China Internet Network Information Center (CNNIC), the number of Internet users in China had reached 456 million by the end of last year, a year-on-year increase of 73.3 million from 2009. The same year saw the number of mobile Internet users hit 303 million, a year-on-year increase of 69.3 million.

These figures, together with China's rising global economic clout and the increasing level of consumer spending, provide an alluring growth story for US investors.

"The story of China's growth and Internet has a secular and cyclical component," said Richard Lacaille, chief investment officer of State Street Global Advisors.

He said that many investors are watching carefully to see how the Chinese economy develops as the government attempts to control inflation and the high level of credit expansion.