Taiwan buyouts: Back from the brink?

When is a Taiwan deal not a Taiwan deal? Last year, TPG Capital completed one of China's largest ever control buyouts when it paid $500 million for HCP Packaging, a Shanghai-headquartered packaging company that serves cosmetics, skincare and fragrance industries globally. Although HCP has very much been part of the mainland China growth story, its origins can be traced back to Taiwan in the 1960s.

TPG was buying into the global expansion of a China business, but HCP's Taiwanese DNA should not be discounted. Its founders, the Chen family, belong to the group of entrepreneurs who were early entrants to the mainland, bringing capital, knowhow and a degree of international experience, and building successful businesses.

HCP is not alone among these companies in coming under private equity control. In 2011, Apax Partners paid $250 million for Golden Jaguar, a restaurant chain founded in Shanghai by Taiwanese entrepreneurs who decided that nationwide expansion would be best executed under new ownership. Hotpot chain Xiabu Xiabu is now with its second private equity owner, with Actis selling to General Atlantic last year.

"A defining story of the Taiwanese economy over the last 20 years is entrepreneurs who have been very successful in opening and expanding businesses in the mainland," says Mark Chiba, partner and chairman at The Longreach Group, a North Asia buyout firm with investments in Taiwan.

"The upside of going via Taiwan you should be able to get control, a reasonable valuation, leverage, management change if needed, and play into that mainland story. To us, that is more attractive than taking minority bets in mainland Chinese companies."

Many of these businesses date back to the 1960s, and some were in operation during the Japanese occupation two decades earlier. Now under their second or third generation of family ownership, the shares have been dispersed widely, which can present problems for corporate governance. PE investors have the capital and skills to consolidate these shareholdings, put in professional management and get these companies back on the right track.

This is one of two clear themes that emerge from Taiwan's cluster of potential buyout opportunities. The other lies in the technology sector, which emerged as a bulwark of the island's economy on the strength of an original equipment manufacturing (OEM) model that is now being called into question.

"We need a change of business model and an infusion of capital, and private equity is good at this," says C.Y. Huang, president of FCC Partners and chairman of the Taiwan M&A and PE Council (MAPE). "One of the things I have been saying to the government is that private equity can help transform the Taiwanese economy."

But is the government listening? After several years of uncertainty, the answer might finally be yes. Promises of reforms to deal approval processes represent the first step in a turnaround in Taiwan's attitude towards foreign buyouts - although everyone AVCJ spoke to was quick to qualify their remarks with "but it's still early days." Given past disappointments, this is not surprising.

Peaks and troughs

Taiwan emerged from relative obscurity to become one of Asia's most active buyout markets in 2006-2007. Private equity investment reached $9.4 billion during the period, according to AVCJ Research, nearly two thirds of this driven by large control deals. Only Australia and Japan, the region's leading leveraged markets, were more active on the buyout side.

Deal flow dropped as a result of the global financial crisis and it has yet to pick up again. In the past four years, PE investment has topped $300 million on just one occasion, reaching just $56.9 million in 2012. Taiwan may be the seventh-largest economy in the region but last year it ranked 16th by deal value, sandwiched in between Sri Lanka and Pakistan.

The recent history of the asset class in Taiwan can be broken down into two phases: pre-Advanced Semiconductor Engineering (ASE) and post-Yageo.

ASE, the leading domestic semiconductor packaging player, was subject to a privatization bid from The Carlyle Group and its chairman in late 2006. They offered $5.6 billion, then upped it to $6 billion, but still failed to find favor with ASE's advisory panel. Carlyle subsequently withdrew the bid.

Despite the Financial Supervisory Commission (FSC) stating that it would welcome any bids for listed companies if they helped local markets internationalize, industry participants were suspicions of the agency's motives.

It also appeared to set a pattern for regulatory obfuscation. Since 2010, Taiwan has seen two buyout deals in excess of $30 million and both were either significantly delayed or cancelled due to government intervention. By comparison, South Korea blocked just three of 31 during the same period while Singapore hasn't blocked any at all.

"They used to keep asking for more facts, information and justification - what you were supposed to do was be smart and recognize it was their way of telling you to go away," says William Bryson, chairman of the American Chamber of Commerce in Taipei's (AmCham) private equity committee. "Word got around fast as to what happened on that deal and for years PE didn't come here."

Bryson was working on a much smaller take-private deal while the ASE process was ongoing and it closed successfully in three months. But it wasn't a high-tech company, it was much lower-profile and the ticket size was tiny by comparison.

Having said that, one of the reasons most market watchers were convinced the Yageo deal would go through in 2011 was because it wasn't ASE. KKR was already an investor in the company when it teamed up with founder Pierre Chen for a buyout. They bid $1.6 billion, which equated to a public market valuation Yageo hadn't seen in seven years, for an electronics components manufacturer that didn't have the scale to sit beside Taiwan's corporate elite.

Numerous theories circulate as to why the transaction was rejected. While most focus on the regulators, it would appear that KKR and Chen are not blameless. As one industry participant familiar with the situation puts it, "KKR backed the wrong guy. They fundamentally misunderstood the level of antagonism that existed towards Chen and towards the private equity industry."

For all that the buyers' reassurances that they planned to grow the business and create jobs, the media response was hostile. Such reactions are not unknown in markets where there is less familiarity with private equity and greater readiness to label practitioners as asset strippers.

"The media can be a problem because it seems to take a negative view of private equity and clearly this has had an impact on the regulators," says Janice Lin, an equity partner at Tsar & Tsai Law Firm. "I don't think Taiwan in general has a negative view of the asset class - a lot of business people now understand the good side of private equity investment."

Mixed messages

What KKR did do - to its credit, according to several market watchers - is refuse to withdraw the bid, inviting the regulator to issue an official rejection. And when the rejection duly came, the regulator's reasoning drew contempt from the investment community.

The Investment Commission, a group within the Ministry of Economic Affairs tasked with reviewing foreign deals, told the prospective buyers that they had not mollified doubts "about shareholder and investor protections, whether the offer price is reasonable, and the level of transparency of information disclosure."

The bid of NT$16.10 per share represented a 14% premium over Yageo's previous closing price and it was accepted by a majority of minority shareholders. Since then, the company's stock hasn't come close to matching the offer price - it is currently trading below NT$10.00 - so those shareholders effectively lost out because the deal was rejected.

"We were told that about 10 deals were lined up behind Yageo, ready to go had it gone through. When Yageo was rejected they all went away," says AmCham's Bryson. "That shows you the effect a single deal can have. The ASE deal created an impression among other PE investors that Taiwan had become a hostile environment; Yageo confirmed it."

In a bid to address these concerns, AmCham's private equity committee was formed, with participation from a number of regional PE firms as well as foreign and local banks and law firms. Coordinating their activities with MAPE, the mission was to educate and advocate - essentially doing a better job of explaining how the industry works, what it can contribute, and how Taiwan was missing out.

Going into meetings with government officials, at the top of their wish list was regulatory clarity.

First, they called for the publication of guidelines on investment criteria. A string of concerns have been expressed by regulators over the years including the impact an acquisition would have on domestic capital markets and supply chains, the need to preserve national economic security and a duty to protect minority shareholders. private equity firms don't know where they stand.

Second, they asked for a list of sectors and companies in which foreign PE investment is unwelcome. Officials have already indicated privately that bank deals would only be welcome if the targets were in distress, insurance sector investments would be approved if they come with a guarantee of a minimum 10-year horizon, and Taiwan's "national champions" are off limits.

Third, if a deal is rejected, the FSC should a detailed explanation that is consistent with the published guidelines. And fourth, the assessment process should follow a specific timeline so that investors are not repeatedly called upon to provide documentation in support of deals that are unlikely to happen.

"We need certainty and we need it in writing - this will set a precedent so we know how to structure deals next time," says a source who participated in the meetings. "We also need specific deadlines. There are cases where proposals are submitted and they never get rejected but neither do they ever get approved. That doesn't work for us."

Enter the reformers

The big question is whether the "Yageo Act" - shorthand for proposed amendments to the Statute for Investment by Foreign Nationals - and alterations to the Business Mergers and Acquisitions Act will have the desired effect. Certainly, it promises a more transparent approvals process. The consensus is that the legislation is unlikely to go as far as investors would like but it represents a positive first step.

Of course, changing the rules is one challenge but shifting longstanding attitudes - that impact the discipline with which rules are followed - represents another.

"It's good that some of the legal requirements have been clarified but I don't think the changes are necessarily trying to ease concerns about private equity," says Lin of Tsar & Tsai. "The amendment reflects the views of cabinet members who are more pro-business, recognize that it's difficult to do M&A in Taiwan, and would like to relax some of the regulations. But when it was first proposed more conservative elements added other measures."

She cites the inclusion of a clause in the M&A Act intended to further protect minority shareholders' interests by raising the voting threshold required for a take-private deal to go through. As it stands, a proposal requires majority support if the meeting is attended by shareholders representing two thirds of total outstanding shares, and two thirds majority support if the meeting is only attended by a more than 50% majority of outstanding shares.

This may now change so that two thirds representation is mandatory for a de-listing to occur, although FCC Partners' Huang observes that private equity investors would prefer a higher threshold and consistent application to a lower threshold and arbitrary rulings on deals.

Other issues are harder to pin down. For example, Taiwan's regulators are generally uncomfortable with leveraged transactions and this has seen investments win approval only when a host of conditions are attached, such as debt-to-equity ratio ceilings and enhanced reporting duties. These restrict the buyer's flexibility to generate financial returns.

It is hoped that an FSC described to AVCJ as "overly paternalistic" can make the transition from staunch conservatism to free-market pragmatism.

A change at the top of the agency may represent a new broom. Yu-Zhang Chen, who stepped down as chairman of the agency earlier this year, was criticized for being heavy handed and unfriendly to foreign investors, including private equity. His replacement, Ming-Chung Tseng, is regarded as more liberal. Tseng's reputation at the FSC's Financial Examination Bureau was one of toughness but accessibility.

As several industry participants point out, this isn't a bad combination for PE investors who want to their concerns to be heard and then receive a clear response.

"From what he has said to the local press, Tseng is open-minded, certainly compared to his predecessor, who was very conservative and low profile," adds Dennis Chiang, head of financial advisory in China Development Industrial Bank's corporate and investment banking division. "He is much more supportive and will encourage foreign private equity."

But he warns that, even with a new FSC head, change takes time. This might explain why foreign private equity firms are still wary of hailing the start of a new era in Taiwan.

Sustainable deal flow?

AVCJ asked managers from three pan-Asian buyout funds for their take on the market. One was guardedly optimistic, pending successful adoption of the proposed reforms; the other two were more skeptical, one of them noting that his firm's recent inactivity in Taiwan had little to do with regulatory uncertainty.

"It's a small market with not very fast growth," he said. "Give us a choice between expending resources there and spending time in China, we'll take China."

This begs the question of how significant the Taiwan private equity market can realistically become. Of the $9.4 billion deployed across nearly 100 deals in 2006-2007, roughly 70% was split between six bank investments and five cable television investments.

At the time, Taiwan's banks were struggling with capitalization issues that had previously troubled their Japanese and Korean counterparts, and in each market PE came to the rescue. The window is no longer open. Further cable TV deals are also unlikely given the industry is now dominated by a few well-established players.

It is therefore difficult to see where the deals might come from that return Taiwan PE to its former glories. The counterargument is that it is very difficult to predict future openings - before Carlyle and MBK Partners made their forays into cable TV no one had been there - although big picture issues such as succession planning, corporate restructuring and cross-border expansion will likely feature in some way.

Even if Taiwan can't eclipse the previous peak, the market surely has more to offer than last year's $56.9 million - enough to move it up the PE rankings. For some, Taiwan doesn't have to rise far to be attractive.

"We have consistently been interested in Taiwan because, like Japan, it's a very tough market to crack so if you have some inside angles and positioning it's a good market," says Longreach's Chiba. "Also, it's a small market so most GPs don't see the need to be there. We believe competition is the enemy of returns, so we like Taiwan."

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• Topics
• Buyouts
• Greater China
• Regulation
• Taiwan (China)
• buyout
• regulation
• China
• TPG Capital
• The Carlyle Group
• KKR
• The Longreach Group Limited