Developing World Healthcare Blog

Chinese ADR Privatizations: The Challenges of Getting the Best Deal

The stellar performance of China’s stock markets over the past twelve months (Shanghai +121%, Shenzhen +161%, and Hong Kong +17%) has led to a sharp uptick in going private transactions involving Chinese ADRs. The wide disparities in valuations between these markets (Shanghai average P/E of 25x; Shenzhen average P/E of 75x) and the US (S&P 500 P/E of 19x) along with the replica handbags uk successful re-listings of Luye Pharma (formerly in Singapore) and 3SBio (formerly in the US) in Hong Kong have emboldened the Chairmen/CEOs of other US-listed Chinese companies to engage in what some have called “exchange arbitrage.”

The challenge for shareholders of these companies is obtaining a fair price in these transactions. The Board of Directors has fiduciary responsibility to negotiate the best deal for hublot replica watches unaffiliated shareholders, but the hurdles can be significant:

  1. Most China ADRs are incorporated in the Cayman Islands or BVI which have weaker protections than Delaware.
  2. Management teams may be unwilling to support a deal without Chairman/CEOs approval, reducing the likelihood of 3rd party offers.

“Toto, I’ve a Feeling We’re Not in the Delaware Court of Chancery”

The vast majority of Chinese companies with ADRs are incorporated in either the Cayman Islands or the British Virgin Islands (“BVI”), which have weaker protections for minority shareholders compared to Delaware. For instance, the threshold for approval under The Companies Law of the Cayman Islands is two-thirds of the voting shareholders, including the buyout group. In cheap michael kors handbags contrast, Delaware requires a majority of the minority shareholders’ (excluding the buyout group) approval. As a result, a management group with a replica watches substantial voting block has a very strong negotiating position. Conversely, a management team with a smaller stake will have to put a better offer on the table. One other important difference is the inability to bring a class action suit in the Cayman Islands and BVI on behalf of all public shareholders. There are dissenters’ rights, but these are individual actions that would benefit only the plaintiff.

Boards of Directors Can Face Obstacles in Exercising Fiduciary Responsibilities

Upon receipt of a going private offer, the Board of Directors will form a special committee of the independent directors to evaluate the offer, negotiate terms, and make a christian louboutin outlet recommendation to stockholders. The special committee will hire counsel and a financial advisor to assist in this process. The financial advisor will perform an analysis of the offer and provide the special committee with a “fairness opinion.” The opinion will include the following analyses (with drawbacks noted):

Discounted cash flow (DCF) – The DCF calculates the value of the business based on future cash flows available to stockholders (“free cash flow”.) The disadvantage for rolex submariner replica watches stockholders is that these analyses typically rely upon management’s projections that may be reasonable, but certainly not heroic. For example, 3SBio’s proxy for its 2013 going private deal included forecast results through 2018. Management estimated 2014 revenue and net income of RMB824M and RMB116M, respectively. The actual 2014 results (from the company’s HK IPO prospectus) were revenue and net income of RMB1,131M and RMB292M, respectively.

Peer group comparisons – This analysis compares the offer price to the valuations of similar publicly-traded companies and valuations of acquisition of similar companies. The quality of this analysis is a function of the number of similar listed companies and precedent transactions; and the dispersion of the data. An example involves China Cord Blood, nike outlet which is subject of a going private offer that values the company at roughly 7.5x trailing EBITDA. There are virtually no acquisitions involving similar companies. There are a few public companies: 

  1. Singapore-listed Cordlife Group (16x EBITDA)
  2. Kuala Lumpur-listed Stemlife Bhd (negative EBITDA, so no EBITDA multiple) 
  3. Shanghai-listed Zhongyuan Union Cell & Gene Engineering (128x EBITDA)

The range of valuations is so broad that almost any price above the current offer looks “fair.”

We should note that a management group’s refusal to consider offers from third parties (as was the case with 3SBio) can hamstring the special committee’s ability to solicit competing offers, and moncler outlet negotiate better terms. The proxy filing for the transaction discloses the evolution of the negotiations, including the management group’s attitude toward third party offers. Disclosure of these facts alone can lead to a bump in the price, but doesn’t necessarily lead to full value.

What to Do When That Buyout Offer Looks Low?

The best advice we’ve received from colleagues with expertise in “event driven” investing is to make a case in public for better terms to put some pressure on the special committee. Exercising dissenters’ rights is expensive, so sending an “open letter” to the special committee and the media can be a cost-effective alternative.

More broadly, investors must consider the risk of a “lowball” offer when valuing investment opportunities among Chinese ADRs. Key questions include: How much control does management have? What have been the valuations of similar going private deals? Incorporating these factors into the “margin of safety” analysis should increase the probability of making money even if a going private offer undervalues the business.

 

The author owns shares of China Cord Blood and Cordlife Group.