MSPE Asia singles out Yongye as a value proposition

This is not the first time private equity has moved in for a mid-cap Chinese company that is perceived to be undervalued. In the last two years, a number of funds have teamed up with company management to privatize firms languishing on foreign exchanges with a view to relisting elsewhere. MSPE Asia did precisely this with drug maker Sihuan Pharma, which left the Singapore bourse in 2009 and listed in Hong Kong last year.

Yongye, a PIPE deal rather than a privatization, stands out because the company went public in the US through a reverse merger. Quicker and cheaper than an IPO, this listing method generally involves less regulatory scrutiny as there is no public capital-raising. But after discrepancies were first identified in the financial statements of several firms late last year, hedge funds began circling all Chinese reverse merger stocks in search of shorting opportunities.

Valuations - a secondary concern

When questions were first asked of Yongye in March, MSPE Asia was already well into its due diligence process, a source familiar with the deal tells AVCJ. The factual detail in these reports - as distinct from the negative spin - didn't throw up any surprises, and it certainly did no harm to MSPE Asia's negotiating position.

"It's fair to say that it made it a more attractive investment - it was a source of incremental risk to be borne by the company, not by the investor," the source says. "But overall, price discovery context is typically secondary to conviction on company fundamentals, and this was no exception."

For its part, MSPE Asia sees Yongye as a leading player in an underpenetrated market. "The company's core products address an important need for farmers to enhance yield for crops planted on soil that has become degraded by decades of over-fertilization," Homer Sun, Managing Director of MSPE Asia, said in a statement released by Yongye. As part of the deal, Sun will join the company's board.

MSPE Asia has agreed to purchase $50 million of preferred shares, which will convert into common stock within a five-year period at an initial price of $8.80 per share. The price is subject to upward and downward adjustments - up to a maximum of $15 per share - based on Yongye achieving net income targets of $84 million in 2011, $126 million in 2012, and a cumulative total of $682.5 million for the fiscal years 2011 through 2014. MSPE Asia also has the right to acquire more common stock should the company fail to meet its profit targets or chooses to issue new shares. Yongye recorded net income of $48.4 million in 2010.

As the fallout from the reverse merger scandal continues to unfold, market watchers expect to see more investors pursue undervalued companies, either via public markets or through private acquisitions. To give one example, NASDAQ-listed supermarket retail chain QKL Stores is currently trading at a forward price-to-earnings ratio of 11. Its Hong Kong-listed competitors Beijing Jingkelong and Wumart Stores have forward P/E ratios of 19 and 32, respectively.

"There is a lot of interest in privatizing these companies because the valuations are so attractive. And due to the short attacks many valuations have become even more depressed so obviously private is interested," says John Ma, head of Asia capital markets at Roth Capital, which covers around 65 mid-cap Chinese firms listed in the US.

Privatizations in the pipeline

As of May 26, eight of these 65 are currently involved in privatization activities, while three transactions are completed and one has been abandoned. Those underway include: a merger between China Fire & Security Group and Amber Parent, an affiliate of Bain Capital Partners and Amber Mergerco; TPG partnering with the CEO in the privatization of CNinsure, a company already part-owned by CDH; Chemspec International's proposed delisting and merger with a company owned by the CEO and Primavera Capital; the acquisition of Funtalk China by Fortress Group, an entity owned by ARC Capital and other existing shareholders; and privatization plans launched by the CEOs of Fushi Capital and Harbin Electric, both in conjunction with Abax Global Capital.

Ma said he knows of at least 12 other companies that have been approached by private equity firms. He expects more deals to follow as those currently underway are completed, but notes that the market is volatile with many other considerations potentially coming into play. "Everyone knows you have to be selective with these companies," he says.

Carlyle Group is all too aware of the risks involved. China Agritech, a Chinese mid-cap company in which the private equity giant holds a 22% stake, faces class action law suits for allegedly falsifying earnings statements. The company was forced to de-list from NASDAQ in May and its stock is struggling on the over-the-counter markets. Meanwhile, the CEO of another Carlyle portfolio company, Hong Kong-listed China Forestry, was arrested in February on embezzlement charges.

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• Topics
• Greater China
• PIPEs
• Morgan Stanley Private Equity Asia