China take-privates, part 34

The $3.5 billion MBO touted for Focus Media takes the China take-private trend up a notch - but it's not new. And given the amount PE investors have talked about these opportunities in recent months, not to mention the amount I've written about them, it shouldn't be that surprising. And, yes, the complications and risks inherent in such transactions remain the same.

On a broader level, depressed public market valuations create a natural inroad for private equity. According to AVCJ Research, investment has slowed throughout Asia over the last 18 months, reaching a three-year low of $26.2 billion in January-June 2012, but buyouts and PIPE deals are not responsible.

These two categories between them racked up $16 billion in transaction value in the first half of 2011 (47% of the regional total), $21.8 billion in the second half of 2011 (60.8% of the total), and $16.9 billion in the first half of 2012 (64.6% of the total). By comparison, growth deals have slumped from $12.8 billion to $8.3 billion to $7 billion over the same period.

Private equity firms will place capital where they perceive value and feel they can wield sufficient influence in realizing it. Public market transactions will continue to play a large role as long as valuations allow it.

Chinese companies listed in the US have been hit particularly hard after financial inconsistencies were uncovered in filings made by several firms that went public via reverse mergers. Short sellers have also launched attacks on a number of these firms. Plummeting valuations have prompted management teams to consider going private and relisting in Asia.

The Focus Media MBO has attracted attention not only for its size, but also because the company has been targeted by Muddy Waters, arguably the most notorious/successful of the shorts. It accused Focus Media of overstating the number of screens it uses to display ads in China and of overpaying for acquisitions, and the stock tanked; the company denied the claims, and the stock largely recovered.

Focus Media isn't the first to be placed under such scrutiny and respond with a PE-backed MBO. Harbin Electric (completed), FushiCopperweld (pending approval), China Fire & Security (completed) and CNinsure (terminated) have also had questions asked of them.

According to Roth Capital Partners, 37 China take-privates have been announced, completed or terminated since 2010. PE investors are involved in four of the 14 completed deals and four of 18 that are ongoing. Quality inevitably varies and this affects the chances of a deal going through and then achieving the ultimate objective of a relisting in Asia, a feat that so far none of these companies has achieved.

Focus Media is large, well known and profitable. It was taken public by credible investors (CDH Investments, Draper Fisher Jurveston, 3i Group, and others) and is poised to be taken private by credible investors (The Carlyle Group, CDH, China Everbright, CITIC Capital and FountainVest Partners), supported by credible financiers. Crucially, the company is incorporated in the Cayman Islands, a jurisdiction regarded favorably by the Hong Kong Stock Exchange.

On the flip side, a company might be incorporated in Nevada, and re-domiciling to Cayman could incur a US tax bill large enough to make the whole exercise financially unviable. It might also be unprofitable, which would fall foul of Hong Kong's merit-based review system. Even if structural challenges are overcome, does the company appeal to investors in Asia. A lack of brand-name recognition, a puzzling business model and Chinese policy bank backing are unlikely to inspire confidence.

As many investors have discovered, it is dangerous to pick winners - or trends, for that matter - without proper due diligence.

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• Topics
• Buyouts
• Greater China
• PIPEs
• buyout
• China
• PIPE