China take-privates: Dangerous demand?

Take-private deals involving US-listed Chinese companies used to be relatively straightforward, and in some respects they still are. A founder-CEO looks at the valuation his business has achieved in the US, examines where comparable companies are trading in China, factors in the compliance costs of a US listing, and asks himself whether it is worth the effort. At some point in this process, private equity gets involved, prodding the founder in the direction of a take-private with offers of financial support.

They submit an offer, perhaps roping in any significant existing investors that want to take part in the buyout; and if the founder has a controlling stake in the business, getting shareholder approval is rudimentary in most jurisdictions. Completion takes time, but assuming shareholder lawsuits can be handled, financing is in place, and there are no challenging tax ramifications to dismantling the corporate structure, those involved can navigate the process with a degree of confidence.

AVCJ has records of around 80 take-privates since 2010, many but not all of which featured private equity. Over half were launched in 2015. These could be described as the post-Focus Media wave, in acknowledgement of the $3.7 billion privatization of the outdoor advertising business that not only put China take-privates in the big league dollar-wise, but also marked out a path to liquidity. Thirty months after the privatization closed, Focus Media re-listed in Shenzhen through a reverse merger, giving a string of PE investors a substantial gain (most of it on paper).

This success has given rise to even larger deals and even more demand to participate. Transactions are no longer the work of just one or two private equity sponsors in conjunction with a founder; in some deals, international GPs have been pushed to one side by local funds, insurance companies, sovereign wealth funds, and high net worth individuals - in short, whatever combination of pricing, flexibility on terms, and regulatory leverage works best.

In these circumstances it is perhaps only logical that investors compete for deals. When the founder and CEO of iKang Healthcare Group teamed up with FountainVest Partners on a bid last year, a consortium featuring industry rival Meinian Onehealth responded by tabling a higher offer. This led to a protracted and still unresolved battle with more and more heavy artillery brought into the fray: on one side stand the likes of Sequoia Capital, Cathay Capital and Shenzhen Ping An Decheng Investment; on the other, Ontario Teachers' Pension Plan, Legend Capital and China Life.

China International Capital Corp. (CICC) also partnered with a strategic player to counter a buyout bid for Sinovac Biotech submitted by the company chairman and SAIF Partners. Meanwhile, in the cases of recruitment portal Zhaopin and auto listings platform Autohome third parties (CDH Investments and Ping An Insurance Group, respectively) made the first move and management responded by working with private equity to try and put together a better deal.

As to where all this might end - the public markets slowdown that started in mid-2015 did not bring take-private activity to a standstill - the regulator offered a hint last week. While scotching reports of a suspension in listings by companies previously taken-private in the US, a China Securities Regulatory Commission (CSRC) spokesman said the potential market impact of IPOs, M&A and restructurings of this nature. He pinpointed the valuation gap between domestic and overseas markets and investors speculating on shell companies.

The inference is reasonably clear. The privatization-domestic re-listing thesis is no longer the preserve of sophisticated capital providers: from the 36 parties connected with Qihoo's privatization to the 36 investors that bought shares in Focus Media several months before the reverse merger was completed, participation is proliferating. It is unclear who these new entrants are or how much they really know about what they are buying.

The take-private opportunity cannot last forever, but as long as it does, the government wants to minimize potential damage to the market and to retail investors. Closer regulatory scrutiny is therefore likely to make it harder for companies to re-enter the public domain via the A-share market. This doesn't mean the door has closed, rather that only quality companies with quality backers will be allowed in.

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• Topics
• Greater China
• Buyouts
• IPO
• China
• regulation
• CSRC