I wrote this article for the May 2014 NEDRA News Blog (boy, it doesn't seem that long ago), and as I was preparing for a presentation on prospect research in Asia, it came back to me. I hope those of you who do research on international prospects will find it useful!
Foreign Companies on American Exchanges: Demystifying ADSs
by Laura Parshall
To the international prospect researcher, finding that a prospect who needs rating is a shareholder at a publicly listed company is not unlike finding a back-roads route from your office to your home that avoids traffic and cuts your evening commute in half: it gets you to where you want to be a lot faster, and with less frustration. It's a Holy Grail. Finding out that the company in question is listed on American stock exchanges seems like an additional bonus: it's easy to look up the share price, and there's no need to convert currencies, right? Well…it isn't exactly that simple. The units being traded on American exchanges aren't exactly the same thing as the company's common stock.
For U.S. investors, buying shares of common stock in a foreign company would generally entail currency conversion issues, as well as various kinds of administrative red tape that would understandably make some people disinclined to make those investments. To make life easier for U.S. investors--and, by doing so, to gain a wider investor base for themselves--foreign companies can list something called American Depositary Shares on U.S. exchanges.
Investopedia.com defines American Depositary Shares (or ADSs) as "A U.S. dollar-denominated equity share of a foreign-based company available for purchase on an American stock exchange. [They] are issued by depository banks in the U.S. under agreement with the issuing foreign company; the entire issuance is called an American Depositary Receipt (ADR) and the individual shares are referred to as ADSs." A U.S.-based investor who buys 500 shares of, say, Hong Kong company Soufun Holdings on the NYSE is actually buying 500 ADSs; the share price listed in such places as Yahoo! Finance or Marketwatch is actually the price per ADS.
So, they're called something different. Not such a big deal, right? So let's take a look at our prospect's holdings, and find out how much they're worth. As a random case study, let's say we're looking at Quan Zhou, a board member at Soufun Holdings. He's a partner at the Beijing office of a venture firm, but for the sake of this exercise, let's ignore that and pretend he holds all those shares directly, and none belong to the firm. To find out how many shares he holds, we look at the annual SEC filing of the company, Form 20-F. Soufun filed one most recently on March 28, 2014. In that filing, it states that Quan Zhou holds 2,544,357 Class A ordinary shares. OK, so now we just take a look at the company's share price on our favorite site, and multiply, right?
At the time of this writing, the most recent closing price listed for Soufun is US$13.36. If we simply multiplied that price by the number of shares listed next to Zhou's name in the filing, it would look like his holdings were worth roughly $34M. It’s a nice number, sure, but it's not the right one.
See, common shares and ADSs are not always created equal. There's a set ratio that states how many common shares equal one ADS. What's the ratio? Have no fear, Form 20-F will tell you! Near the top of the form, you should see a note that gives the equivalence ratio for ADSs, usually right underneath the contact information for the company. In this most recent 20-F for Soufun, it says that five American Depositary Shares are equal to one Class A ordinary share. Got that? FIVE to ONE. That means that our friend Zhou's 2,544,357 Class A ordinary shares are equal to 12,721,785 ADSs. At the price we used before, this means that his holdings would be worth almost US$170M. That's quite a difference!
In Zhou's case, using the correct ratio of ADSs to ordinary shares resulted in a higher value than just assuming a one-to-one ratio. This isn't always the case, though. That's why it's so important to check the Form 20-F for the correct ratio. Sometimes, as with Indian company Wipro Ltd., it IS one-to-one. Sometimes, as with Korean company POSCO, one ADS is LESS than one common share. It takes four of POSCO's common shares to make one ADS. If you were researching a shareholder there and didn't take this fact into account, you could end up overestimating the value of their holdings by four times!
So, if an international prospect who's a major shareholder in a publicly traded company is something of a Holy Grail, the existence of ADSs makes it a bit like a Holy Grail manufactured by IKEA: some assembly is required. Just make sure you know when you're looking at ADSs (or ADS price), and when you're looking at common or ordinary shares, and remember to check the ratio between the two. With over US$2.5T in ADSs traded in 2013 (according to BNY Mellon), it's definitely worth the while of any international prospect researcher to know how to work with them.
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