Taizinai puts China risk on show

Actis Capital, Goldman Sachs, and Morgan Stanley investee Taizinai has now stated that it does not recognize the winding-up order on its Cayman Islands holding company, arguing that the business is only answerable to Chinese law. And the municipal government of Zhuzhou in the company’s home province of Hunan appears all too likely to back them up.

Debts and enforceability

The private equity troika invested $73 million for about 30% of the company in 2006, prior to a planned IPO, with Actis committing $40 million, Morgan Stanley – but not Morgan Stanley Private Equity – $18 million and Goldman $15 million. Taizinai owes money to banks including Citi, DBS, RBS, Belgium-based KBC Group and China Merchants Bank.

Just after the original investment, Taizinai – known for its probiotic yoghurt drinks – went on an expansion spree before the 2008 scandal over melamine contaminants that slashed demand for Chinese milk products. The company built new manufacturing and distribution facilities across China. This, as much as the public health scandal, appears to have been the cause of its problems. The proposed IPO in Hong Kong or the US was premised on the company’s ability to raise up to RMB3 billion ($439 million) through a share issue, and never materialized.

“When you make a bet in somebody in this environment, you’re really throwing caution to the winds if you’re a minority [investor],” said Dane Chamorro, Managing Director for Greater China/North Asia at Control Risks. “No local court is going to go against Taizinai.”

“We have a policy of taking an active role in all our investee companies and we work closely with the management teams to add value wherever we can, so we are clearly very disappointed that Taizinai is in liquidation,” an Actis spokesperson told AVCJ. “It is the nature of the private equity business that some of the companies in which we invest will not succeed, and even with the support of our global networks and expertise, sometimes developments are beyond our direct control.”

Provisional liquidator Borrelli Walsh apparently aims to replace Taizinai’s directors with its own appointed team to restructure the business. However, Taizinai has apparently been in informal restructuring since February 2009 under the direction of the city government of Zhuzhou, which has the final word on any attempt to change directors.

Taizinai may in fact have been guilty of no criminal wrongdoing, which makes the investors’ enforcement position even more difficult to implement, given the nascent nature of China’s own bankruptcy laws. “Foreign court judgments are not enforceable in China,” Chamorro pointed out. “If there’s no demonstration of bad faith, fraud or something else, why would a Chinese court rule in your favor?”

Repeated restructuring

Actis, Goldman and Morgan Stanley tried to deal with Taizinai’s problems back in October 2008, when AVCJ reported moves by the three to invest a further $30 million in the company, on the condition that company chairman and founder Li Tuchun sell his stake.

Taizinai had apparently stopped new construction and delayed payments to staff and business partners as early as July 2008, prior to the first reports of contaminated milk products in China. Goldman sent provisional liquidators into the business in October of that year.

However, the earlier restructuring efforts failed, and Li Tuchun, a Hunanese native who founded the business in 1996, still owns 61% of the company. The Zhuzhou government has apparently been struggling to find new investors for the business; its main concern is to preserve local jobs. Unfortunately, the Hunan province has an unenviable reputation as “the Sicily of China.”

Creditors and rights

Similar to the all too familiar Asia Aluminum situation, Taizinai appears to be continuing irrespective of the holding company’s debts. And, equity investors are likely to be last in line behind bank debt holders to receive any residual value, even from a successful restructuring.

As to the investors’ reasons for making such risky commitments, this probably came down to the deal-driven nature of investing. “These guys are under a lot of pressure to place money,” said Chamorro. “You get into a situation where it’s impossible to say ‘no’, even if you come across something that gives you pause.”

Ironically, the 2008 milk scandal may have actually increased the opportunities for investment into China’s milk products sector, with buyout major Kohlberg Kravis Roberts & Co. making successive investments in Ma Anshan Modern Farming Co. Ltd. (a.k.a. Modern Dairy) in late 2008 and 2009, and Sequoia Capital China making an investment in American Dairy, Inc. in August 2009. PRC regulators, stung by the crisis, encouraged outside investment into the sector to improve health standards and reputations.

However, while the opportunity remains, so does the risk. “If you’re going to look for returns, where are you going to look?” observed Chamorro. “But that doesn’t change the fact that it’s a very tricky, non-transparent environment.”

The Actis spokesperson concluded, “Our confidence in China remains undiminished, and we are delighted to report that our other Chinese investments … are performing well.”

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• Topics
• Greater China
• Performance
• Expansion
• Buyout
• Goldman Sachs
• Actis Capital
• KKR
• Sequoia Capital
• Morgan Stanley