Showdown at GOME

But as the prompt action of the current GOME board showed, Huang’s efforts to exert his influence, even from custody, were harshly rebuffed.

Attempted coup and response

The drama began at Hong Kong-listed GOME’s AGM on May 11th, when two significant affiliated shareholders voted against the reappointment of Zhu, Reynolds and Wang as directors. Zhu and Reynolds are MDs with Bain Capital Asia and Wang is a principal. “While the shareholder turnout ratio was 62.5%, the combined holdings of the two, representing 31.6% of the entire outstanding shares, were sufficient to deny the reappointments, almost exclusively on their own,” GOME’s board noted.

Faced with an immediate liability of RMB2.4 billion ($352 million) under the terms of its agreement with Bain, GOME’s board, led by current Chairman and President Chen Xiao, took action. “The company convened an emergency board meeting to seek to avert this risk to the company and maintain focus on business growth,” the group said in a statement. “The board last night unanimously agreed to reappoint Bain Capital’s three directors.”

Huang’s motives for engineering this attempted coup just prior to his conviction on corruption and insider trading charges in the PRC, are unclear. AVCJ sources were inclined to put these down to mental instability – according to some PRC reports, he attempted suicide while in prison – or a last quixotic effort to demonstrate his power. His two holding entities, Shining Crown Holdings and Shine Group, still hold around 32% of the company, so these apparently were key to the vote.

Huang, now convicted and facing 14 years in prison, could still try to vote off the Bain directors and any others who support them. “He might requisition a shareholder meeting to remove the reappointed directors. or the entire board It would be up to them to muster the votes to resist that,” David Webb, the leading Hong Kong-based shareholder activist, told AVCJ.

Bain and GOME did try to reduce Huang’s stake through a deep-discount open offer to existing shareholders, underwritten by a Bain fund, in August 2009. However, Huang participated and kept Bain’s stake down to just under 0.2% in the offer, rather the 15.3% they undewrote. Huang and his associates actually increased their stake slightly, from 33.7% to 34%.

Implications and consequences

Huang’s attempted coup would have financially and strategically impaired his own creation if it had gone through. As it is, his action continues to depress the value of GOME’s shares, reducing the worth of his own stake, and impedes the Bain-assisted turnaround plan currently under way to bring the market leader back into contention with Suning and other domestic competitors.

The current GOME board certainly thought so. “We strongly believe this outcome does not represent the will of the vast majority of ordinary shareholders. It emphatically does not represent the will of the entire executive management team and board,” said their statement. “We also believe our strategy is better pursued with the support of Bain Capital as board directors and financial partners.” The statement also confirmed that Bain plans to convert its investment, originally made as convertible bonds, into stock before the next GOME AGM. The bonds are convertible into 10.8% of the current equity.

However, Huang’s differences with his board and his arbitrary actions, let alone the convictions in the PRC, are not enough to disqualify his vote. “Even he had been convicted and was serving jail time, he would still be a shareholder,” Webb told AVCJ. “That doesn’t entitle the board to deprive him of his shares or voting rights.”

According to Webb, one fundamental issue is that Bain Capital was a convertible bondholder but not a shareholder. “When they went into this deal with certain undertakings relating to directors and nominations, they couldn’t expect that to be sustainable,” he told AVCJ. “They would not have lost this vote if they were shareholders, but that would have meant taking equity risk.” However, Bain’s original decision to go with a bond investment seems to have been a calculated gamble.

“They got a pretty generous deal if you look at the terms of the bond,” Webb said. “I don’t think if I was Bain I would have done things differently.

“If you’re investing in China, you have to expect this kind of thing,” Webb concluded.
However, the episode demonstrates the risks for private equity firms in investing in PRC companies in general, but especially those where founders have any overt or covert legal entanglements. The question of the pressures on GPs to invest in hot markets like China is obviously a contributor. “There seems to be a misalignment somewhere,” noted Deidre Lo, Senior VP and Head of Corporate Intelligence at Hill & Associates. Bain Capital did not reply to AVCJ requests for comment.

Other potential private equity investors in GOME are known to have walked away from the opportunity because of these issues. Bain appears to have won this round, but other would-be China investors might well want to take note. 

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• Topics
• Greater China
• Consumer
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• Performance
• Bain Capital Asia