Asia buyouts: The privatization play

In the two years since CHAMP Private Equity closed its third buyout fund, the Australian GP has completed five deals, two of them take-privates. The most recent, Gerard Lighting Group, departed the domestic bourse last month to join earlier acquisition oOh!media, an outdoor advertising company, in the CHAMP portfolio.

Australia has traditionally offered rich pickings for private equity firms chasing take-privates and 2012 is no exception. Pacific Equity Partners (PEP) acquired cleaning and catering contractor Spotless Group in April while TPG Capital has been engaged in the on-again, off-again pursuit of struggling surfwear manufacturer Billabong.

On the other side of the world, take-private transactions of US-listed Chinese companies reached a new high in August as Focus Media received a $3.5 billion offer from a PE consortium. Japan has also been busy, with Advantage Partners buying home builderYasuragi Unison Capital moving for auto parts maker Asahi Tec.

Despite this recent activity, Asian private equity-backed take-private transactions in 2012 account for just a fraction of the volume transacted five years ago. As of October, $1.8 billion had been committed across seven transactions; during the liquidity boom of 2006-2007, when buyouts of all kinds grew exponentially, there were more than 40 take-privates collectively worth $31 billion.

The tougher debt financing environment is partly responsible for the disparity, but the greatest challenge is rooted in the willingness of founders and majority shareholders to take part in such transactions.

"In the generally low valuation environment that has lasted for some time now, take-privates are becoming a more viable option for existing shareholders to pursue an exit," Tatsuo Kawasaki, a founding partner at Unison Capital, tells AVCJ. "But going private does create a little bit of a shock to the company and you need to explain to management and shareholders why it makes sense in this environment."

Timid investors

The public market malaise that facilitates take-private deals is long-standing. While Australia's benchmark S&P/ASX 200 Index is trading at two-thirds of its pre-global financial crisis level, Japan's NIKKEI 225 and Hong Kong's Hang Seng Index are down 50% and 30%, respectively. In this climate, investor expectations have weakened to the point that they are open to offers of immediate or guaranteed liquidity.

"If you think back to our attempted takeover of Flight Center in early 2007, there was a sense that the market was inexorably rising," Tim Sims, founder and managing director of PEP, tells AVCJ. "PE had expressed its interest, and shareholders were able to tell them to go away in the expectation that three months later the market would reward them with a higher share price."

The best examples - in an Australian context - of how perceptions have changed are investment group Perpetual and Billabong. In both cases, take-private offers were spurned and the share prices subsequently tanked.
KKR bid for Perpetual in October 2010, offering A$38-$40 a share for a total consideration of A$1.75 billion. Months of limited engagement followed as the target company repeatedly insisted the offer was too low. When KKR eventually walked away, Perpetual's share price plunged 50%.

In February, TPG was prepared to pay A$841 million for Billabong - or A$3.30 per share, up from a previous offer of A$3 - only for the company's board to demand at least $4 per share. As the company's commercial difficulties became more apparent, its stock began to slide and TPG returned with a A$694 million offer. The board reluctantly opened its books to the private equity firm. TPG withdrew its offer in October after concerns emerged during due diligence and Billabong is now trading below A$1.

Fearful that weak public markets could further undermine the personal worth they have tied up in their companies, founders and shareholders in several markets are - theoretically - more open to a private equity solution. Some company chairmen actively court prospective investors, offering access to assets at cheap valuations.

"A lot of top-tier US-listed China companies, for example, are now trading at a high single-digit, whereas if you source a private business in China, you need to pay something like 12-15x the forward price-to-earnings (P/E) ratio," Donald Yang, managing partner and CIO at Abax Global Capital, explains. "When you look at the quality of corporate governance, internal controls, and financial management, the advantage clearly goes to the listed companies."

For many mid-cap Chinese companies, the main reason they went public in the US in the first place was to raise funds. However, ever since financial irregularities were uncovered at a number of Chinese firms that listed in America via reverse mergers this function has ceased to be valid. Chairmen are paying the additional compliance costs of maintaining US listing and all the while market capitalizations are shrinking.

While not all take-private deals are sponsored by private equity investors, Honson To, head of private equity at KPMG Asia Pacific, suggests that PE firms can provide financial and restructuring expertise to these companies, in addition to capital. Their mere presence can also boost a Chinese issuer's credibility.

"Market participants are eagerly observing the growing trend of take-private transactions and any potential first-mover advantage, although it remains to be seen if such companies can be successfully relisted in a few years' time," Ho says.

Maurice Hoo, global leader of Orrick's M&A and private equity practice group, agrees that PE players who understand the valuation differential between markets are playing a vital role.

"Almost all of these take-private transactions are aimed at going private in the US and then going public in Hong Kong, where the companies should expect to fetch a higher valuation," he says. "This is due to not only an absence of negative publicity, but also an investment public that should understand the company and its business in China much better than in the US."

Inaccessible debt

While low valuations and relatively higher listing costs can present a compelling case for going private, Australia and Japan, which between them account for 60% of Asia's PE-backed privatizations since 2005, aren't seeing anything like the activity of 2006-2007.

Debt financing is a key issue. Banks in both countries are still willing to sponsor leveraged buyouts but there are fewer participants than before and the debt portion of deals is less generous. In Australia, for example, European banks have more or less completely exited the syndication market and the four major local lenders focus on smaller deals. Private equity firms must therefore rely on US and strong Asian banks for support.

"The deal debt margins and the gearing ratios have changed considerably from the peak of the boom to the current position in Australia," says Mark Malinas, co-head of private equity at law firm Allens. "Debt-to-equity ratios of around 4x were common in 2006-2007 and you could get a margin of 2-2.5% over the bank bill swap rate; now you have gearing ratios of around 2x and a margin at around 4-4.5%."

With less debt financing available, private equity players have shifted towards smaller and mid-market deals. Last year, the average PE-backed take-private deal in Australia and Japan came to $252 million and $116 million, respectively; it was $1.7 billion and $604 million in 2007. Another option is setting up club deals, but that may mean a longer and more complicated execution process.

Take-privates for US-listed Chinese companies are on the opposite trajectory, although it's worth noting that debt financing, while available, is limited. Deal flow was negligible in 2006-2007, but 45 transactions have been announced in 2010-2012, 16 of them involving private equity. However an announcement is no guarantee of a closure: only four of these PE-backed deals have been completed as of October, data from AVCJ Research and Roth Capital Partners show.

Abax Global Capital's buyout of FushiCopperweld is expected to close in the fourth quarter, two years after the offer was first submitted. The private equity firm has one successful take-private to its name - Harbin Electric - but this took one year to transact.

Game of chicken

The long execution process suggests that, when calculating the premium to be offered to shareholders, private equity firms and company management should take into account the possible price fluctuations and the changing valuation expectations from shareholders.

Just in the last week, a $1.7 billion take-private bid submitted by CVC Capital Partners and the Malaysian state of Johor for the country's two main KFC fast food franchisees met with opposition from investors one year after the deal was announced. They claimed that the offer came so long ago that the price no longer represents the company's true value.

So there are two issues to consider when dealing with shareholders. First, they may lose interest during a protracted deal process. Second, many company owners in Asia - usually the first-generation founders - are not fond of delisting for prestige reasons and often loath to give up sizeable portions of equity.

"You also need to remember to treat minority shareholders fairly because often a number of them unhappy with the price," says Unison's Kawasaki. "I think it has become clear over the last decade that they may eventually speak out. For people like us, these considerations are very important and we must make sure a transaction is valid from all angles."

In addition, Ken Chen, a Shanghai-based director at L.E.K. Consulting, suggests that China take-privates in particular have been a seller-led game in the last couple of years, given that there is more capital than good companies. A lot of funds raised in the last couple of years are still in the process of use up their dry powder before returning the capital to LPs.

"Private equity players don't want to come across as too desperate during negotiations because it will be made known to everyone in the public market," says Chen. "Both sides have pride and it's like the game of chicken. When the founder turns down the offer, why should we come back to you?"

Should each of the China take-privates announced in 2012 actually close, the region-wide figure would balloon by $6.3 billion. But compared to the boom market in 2006-2007 when asset prices were rising steeply, the current economic outlook is more difficult to predict. PE players are certainly aware of the uncertainties and skeptical about paying high price.

In the face of a valuation expectation gap between buyers and sellers, Christopher Kelly, a partner at Linklaters, says private equity players should emphasize how they can add value to target companies rather than just focusing on geographic arbitrage obtained through buying US-listed Asia assets and relisting them in Hong Kong.

"Most Asia targets are looking beyond the cash that PE houses bring to the table. What they want is some level of expertise for future growth," Kelly says. "Certain private equity houses are now pursuing a ‘buy-and-build' strategy - you purchase the asset, take it private and build the platform by buying complementary assets. The resulting business should be worth more than the sum of the parts and the value created can be realised via an IPO or trade sale."

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• Topics
• Investments
• Buyouts
• buyout
• Australia
• Japan
• China
• CHAMP Private Equity
• Pacific Equity Partners
• Unison Capital
• Abax Global Capital