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Archive for August, 2012

While there are some fairly varying opinions regarding exactly what happened when walmart got conditioned approval for their acquisition of Niu Hai Holdings, one thing at least seems clear: MOFCOM is not overly fond of VIEs.

This certainly won’t be welcomed by foreign investors using VIEs, but its hardly news either. MOFCOM have been the most vocal department when it comes to issues relating to VIEs, for instance in their recent M&A regulations, so a continues negative stance is hardly shocking. What is interesting is how they express their negative views.

They haven’t banned the VIE structure as such, if anything they are acknowledging its existence, but they are limiting the scope under which they will allow it to operate. So far I don’t think this will cause any major issues for Walmart, so from their point of view this is probably a pretty good result.

Other VIEs might want to take notice of the restrictions, however. just in case this turns out to be the start of a trend. While MOFCOM can’t really declare VIEs illegal, they may find a simpler solution in simply restricting their business scope until they are basically useless.

Seasoned watchers of the VIE space will know to take any such hints of future regulatory enforcement with caution though, as we have seen similar things before, with Buddha Steele for instance. What we can say is that MOFCOM certainly doesn’t seem to like VIEs, and if you cannot ban them limiting them is probably your next best option.

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This post was written in collaboration with Jens Ørding Hansen from University of Agder with whom I’m writing an academic paper on Chinese companies going private from the US exchanges.

Last week saw the announcement of the largest ever going private (GP) proposal for a Chinese company on the US exchanges. Focus Media had a market cap over 3 billion USD, pushing the record for largest market cap for a Chinese GP from a previous high of 1.8 billion.

This deal can be seen either as a continuation or a new beginning, depending on your perspective. On the one hand the deal fits the trend of Chinese companies going private from the US that many people expect to continue; on the other hand the deal sticks out from the recent trend in some respects.

The sheer size of the deal is the first, and most eye-catching, way that it sticks out. 75% of GP proposals for Chinese firms fall within a range of USD 50-390 million for market cap, with an average of 288 million. So with a deal over 10 times the average historical value we really are talking about an anomaly.

It could be argued that what we’re seeing here is the start of an exodus trend for the larger Chinese companies that are listed in the US. However, the other big GPs we have seen have not resulted in a discernible trend of large companies heading back to China. What we have seen is that one or two larger deals seem to come before more GP proposals among the smaller firms.

Another interesting aspect of this deal is that it does not include China Development Bank (CDB) funding, something that many thought was going to be the driving force behind the next wave of GP transactions. This was especially true after the CDB agreed to provide funding to help close the Fushi Copperweld deal.

This is not entirely out of character for the CDB as a policy bank, however, as they may be allowing market forces to play out before they decide on stepping in to help close deals. Because there was enough financial backing for the Focus Media deal the bank didn’t actually need to step in, at least not yet.

It might be that the bank is more likely to step in and help conclude some of the old GP deals that have been languishing, seemingly unable to close. There are still 6-8 older GP proposals that are seemingly stuck and not going anywhere. If these proposals are genuine then this might be the best use of the bank’s funds, rather than stepping in and helping deals that would likely close anyway.

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There is currently some debate building about Chinese companies going private from the US exchanges. We saw a wave of these deals a while back but it has been relatively quiet as of late. This could all change, however, with the increased involvement of the CDB to help secure financing for the deals.

While the motivation for taking a company private from the US exchanges is relatively easy to understand, mostly low valuations coupled with the cost of complying with listing requirements. It is more difficult to see where the alternative exit is for the people who go into these deals, something discussed in this article.

Couple that with reports of sharply diminishing returns from domestic IPOs and it seems that a lot of PE funds that were involved are likely to sit on some bad assets. It is certainly fair to say that anyone hoping for a quick delist-relist deal will have been very disappointed with the current situation.

But this does not mean that these deals do not make sense.

One of the major factors why is valuation. The sheer amount of PE money in China at present is pushing up the price of acquisitions, but distrust on the US markets has pushed even the prices of solid profitable companies down. Way down.

Looking at the data we find that the average market-to-book of Chinese companies that have received going private proposals 3 days prior to the proposal is just under 1. This means that the stocks were trading below book value on average, and there are plenty of companies that were well under 1.

With these types of valuations it is possible to offer a good premium and still get a company with a good track record of profitability at fire-sale valuations. The average implied market-to-book of the offers was 1.31. Again these are averages so we even see companies where the implied market-to-book of the offers are under 1.

Now say what you will about the issues of exiting these investments in the future, but with lots of money hanging about in search of a deal in China you would be hard pressed to find more alluring valuations.

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