American Depositary Shares

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21 Aug, 2024

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What Are American Depositary Shares (ADS)?

American Depositary Shares (ADS) belong to a foreign company but are listed on the US financial markets. ADS is traded as a financial product to make foreign shares more accessible to US investors.

Foreign companies issue ADS to attract American investors. But before releasing an IPO, the foreign company must undergo the ADR procedure—American Depositary Receipts. ADS is treated like any other common stock trading in US exchanges like NASDAQ, NYSE, and OTC. Also, investors can convert ADS shares into ordinary shares.

What are American Depositary Shares?

American Depositary Shares (ADS) are common stocks belonging to a foreign company trading as a financial product in the US financial markets.
But ADS requires a share issuance process. The process is known as American Depositary Receipts (ADR). The US custodian bank governs this provision.
By issuing ADS, companies attain global outreach, build a new source of fundraising, expand their business, open up overseas offices, onboard US stakeholders, and hire American employees.
UK Alcoholic beverage company Diageo, German energy company Siemens, and Indian IT corporation Infosys are some famous examples of ADRs.

American Depositary Shares Explained

American Depositary Shares (ADS) are issued when foreign companies trade in US capital markets. JP Morgan introduced this concept in 1927—Americans were allowed to invest in Selfridge shares (a British department store).

Simply put, firms outside the US create ADS to attain global reach. But, more importantly, the company shares can attract US investors if listed on NASDAQ or NYSE.

Not only do foreign firms benefit American investors, but also ADS makes shares belonging to foreign firms more accessible. Without ADS, purchasing shares of a foreign company is a tedious process.

But ADS requires a share issuance process. The process is known as American Depositary Receipts (ADR). ADS is similar to common stocks—they offer either an ownership stake (equity) in the company or dividends. After purchasing ADS, investors can request the custodian bank to convert ADS into ordinary shares.

By issuing ADS, companies attain global outreach, build a new source of fundraising, expand their business, open up overseas offices, onboard US stakeholders, and hire American employees. Many international corporations from Germany, England, and India trade in the US via ADS.

Nonetheless, the move has its drawbacks. Like other foreign exchanges, ADS is prone to liquidity risks. If the timing is not suitable, ADS can backfire. Owing to the United States financial markets' popularity, the newcomer is judged based on performance in the United States stock exchange.

Examples

Let us look at some American Depositary Shares examples to understand them better.

Example #1

Let us consider a hypothetical first.

Walsh owns a furniture company in Berlin. The business already has an extensive reach; for upscaling, Walsh lists his company on the Frankfurt Stock Exchange. Deutsche Börse AG operates the Frankfurt Stock Exchange.

The IPO becomes a huge success, and within two years, his company becomes a multinational conglomerate. Walsh's company now has a global reputation and strong brand recognition.

He observes that his company is more adored in the US market; he wants American investors to invest in his company as well. But, turning American investors to Frankfurt Stock Exchange is challenging due to the complexity of procedures.

Thus, Walsh moves forward by creating ADS for his company. He issues shares in US stock exchanges via ADRs. After completing ADR procedures, Walsh releases an IPO on the New York Stock Exchange (NYSE). This makes it very convenient for US citizens to buy shares. The firm primarily benefits from the added publicity.

Example #2

Now, let us look at a real-world example.

Didi Global Inc. is a Chinese ride-hailing company. In June 2021, Didi raised $4.4 billion in its US IPO. The company sold ADS worth $ 316.8 million—considerably higher than their expectations ($ 288 million) at $14 per share. As a result, the ADS valuation of the company was around $73 billion.

This was the Chinese company's most significant US sale after Alibaba’s massive $25 billion fundraising in 2014. The company was formed by Cheng Wei (a former employee of Alibaba), who also serves as the CEO. Didi president Liu Qing worked with Goldman Sachs for 12 years.

Example #3

In June 2021, Kanzhun Limited released an initial public offering (IPO) of 48,000,000 Kanzhun American Depositary Shares. This leading recruitment firm from China released shares at US$19.00 per ADS.

The total IPO amounted to $912 million. Goldman Sachs LLC, Morgan Stanley & Co. LLC, and UBS Securities LLC are the representatives of Kanzhun IPO underwriters.

Kanzuhn is a network where job vacancies are advertised in China. In addition, the firm employs a dedicated mobile app called ‘BOSS Zhipin.’

American Depositary Shares vs Ordinary Shares

Foreign companies list ADS in the US market. ADS are common stocks of a foreign company trading in the US market. In contrast, ordinary shares belong to US-based domestic companies.
An investor can convert their ADS into ordinary shares, but the ordinary shares of a US-based company cannot be converted into ADS.
Investors must deal with the exchange and conversion rates while trading in ADS. That is not the case with ordinary shares.
ADS is prone to additional periodic service or pass-through fees, which do not apply to US ordinary shares.
Companies belonging to countries that maintain tax treaties with the US can distribute dividends without foreign withholding if the accrued gains are in US dollars. Otherwise, currency conversion fees and foreign taxes are deducted from dividends. In comparison, ordinary shares do not carry any such tax or charges.
Also, a percentage is paid to the broker—for facilitating shares of a foreign company. Again such expenses do not apply to US ordinary shares.

Frequently Asked Questions (FAQs)

1. How to buy American depositary shares?

American investors can buy ADS directly as they are traded on the US financial market like any other share belonging to a domestic company. ADS are issued for the sole purpose of making shares belonging to foreign companies accessible to American investors.

2. How to convert American depositary shares to ordinary shares?

Investors can approach a broker or connect with a Depositary bank representative and request ADR to ordinary stock conversion. This procedure requires submitting relevant documents—parent company's name, number of shares, CUSIP number, etc.

3. Are American depositary shares safe?

Yes, ADS are common stocks of a foreign company made available to the US investors, which in any other case should have been unavailable. Alternatively, if US investors were to buy shares from a stoUsing examples from China, we exchange located in another country, the procedure would and tedious.