Harbin Electric MBO nears finish, despite critics

One of the largest management buyouts of a Chinese company listed in the US, it is expected to add momentum to the spate of privatizations seen in the last year. Three Chinese firms have successfully de-listed from US exchanges and eight more are considering offers from management, often with private equity backing. Harbin, a manufacturer of electric motors, is the fourth of those to receive board support, pending a shareholder vote.

"We are definitely going to see more of these deals in the US," Donald Yang, managing partner of Abax, tells AVCJ. Abax is in talks several US-listed Chinese companies about privatizations, and is already participating in a $439 million offer for bimetallic products manufacturer Fushi Copperweld.

Late comer

Abax wasn't initially involved in the Harbin buyout. When Harbin's Chairman Yang Tianfu made his $24-per-share cash offer on October 10, 2010, he had agreed to work exclusively on the deal with Baring Private Equity Asia. Goldman Sachs committed to providing $470 million in debt financing. Yet, on November 19, news broke that Yang would seek alternative partners, with Baring's participation limited to an option to provide up to 10% of the financing.

The private equity firm declined to comment, but according to a source familiar with the situation, the problem was rooted in the design of the deal. Harbin is incorporated in Nevada where anti-takeover laws make it difficult for an "interested stockholder" - i.e. a party that, together with associates, owns 10% or more of a company, or has owned such a stake in the last three years - to increase its holding. By aligning itself with Yang Tianfu, who owned around 30% of the company, Baring pushed its ultimate goal of crossing the 10% threshold further away, the source says.

Shortly afterwards, China Development Bank's (CDB) Hong Kong branch agreed to lend Harbin around $50 million, guaranteed against a portion of Yang Tianfu's shares in the company. Donald Yang says Abax started talks with the chairman in December.

Under the terms of the buyout, Harbin will merge with Tech Full Electric, a Cayman-incorporated company owned by Yang Tianfu, before the end of the year. The share purchase will be funded through a $400 million loan from CDB Hong Kong as well as $38.8 million in equity financing and $25 million in debt from Abax affiliates. Abax will remain a minority shareholder in the company.

Donald Yang admits that the parties involved are familiar with one another. Abax's investment in Harbin is being routed mainly through Cayman hedge funds but the company also raised a RMB500 million ($77 million) private equity fund in 2009 in which CDB - via its onshore fund of funds - is an LP. And in his previous job at Merrill Lynch, Yang participated in a financing deal tied to Harbin's move from the OTC Bulletin Board to NASDAQ in 2007.

Harbin started out on the OTC because it listed in the US through a reverse merger, purchasing a dormant company that already traded in the US and inserting its own assets into the corporate structure. This process has proved popular with Chinese companies because it is cheaper and easier than a full IPO and involves less regulatory oversight.

However, a number of reverse merger firms have since exposed for overstating revenues, exaggerating market positions, and shifting cash off the books through related-party transactions. Frazer Frost, an auditor under investigation for its role at Dalian Rino, one of the more infamous frauds, is also Harbin's accountant. The company ended 2010 under attack from shareholder lawsuits over the management buyout bid and from short-sellers looking for weaknesses in all Chinese reverse merger stocks.

Short-seller target

Harbin's most persistent critic is Citron Research, which describes the company as "a money pit with hidden liabilities that are consuming its cash." Citron has questioned the veracity of the company's US regulatory filings, asked whether the loan from CDB is genuine, challenged Abax's deal-making credentials, and produced documents which suggest that Yang Tianfu admitted to guilt in a 2004 loan fraud case.

Harbin's stock plunged 51% on June 16, the day some of these claims were published. The company has dismissed Citron's report as factually incorrect but the research house stands by its conclusions.

Following board approval for the bid, Harbin's stock has reclaimed much of the value it lost in the short-seller attack. But at $14.95 on June 24, it remains well short of the offer price - a sign of uncertainty over whether the deal will be completed as much as over the company's financials.

"The current discount is the widest of any of the US-listed Chinese companies that have reached the definitive agreement stage [in a management buyout]," says Mark Tobin, co-director of research at Roth Capital.

Tobin also underlines the level of private equity interest in certain Chinese firms currently languishing on US exchanges. "We believe PE investments, particularly from brand-name firms, can serve as positive catalysts, providing needed capital as well as validation for companies," he adds, noting the impact that Morgan Stanley Private Equity Asia's recent investment in agricultural firm Yongye International had on the stock.

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• Topics
• Greater China
• Technology
• Baring Private Equity Asia