A little over 30 years ago, a new term began to be murmured around company boardrooms – the leveraged buyout, or LBO.
It came courtesy of investor groups who were borrowing money from banks and swooping on low stock market prices to take control of companies.
Taking one of the top spots in the buyout hall of fame was the takeover of RJR Nabisco, a tobacco and food conglomerate purchased by private equity giant Kohlberg Kravis Roberts in 1988 (and later immortalised in Barbarians at the Gate – a dramatic business book later made into a movie).
In later years, Mitt Romney made a lot of his money doing something similar for Bain Capital, although he doesn’t seem to want to talk about it much these days.
Enter Focus Media, which is currently listed on New York’s Nasdaq but makes its money selling advertising on small TV screens in residential and commercial buildings across China. Last week, an investor group announced that it wanted to take control of the company, in a deal valuing it at $3.7 billion. That would be the largest leveraged buyout yet for a Chinese firm, and more than 10 times the historical average for delisting deals of this type, according to China Finance, an industry blog.
The drama of the 1988 RJR Nabisco LBO centred on a bidding war. But for Focus Media the situation is rather different. This is less a hostile, corporate raid than an attempt by the firm’s tycoon founder to escape his US listing, as well as head off the damaging attacks of a short-seller.
So what’s the deal on the table?
An investment consortium including Focus Media’s chairman Jason Jiang has made an offer of $27 for each American depositary share, which works out as a 15% premium on the company’s closing price before the bid.
Focus Media shares rose 9% to $25.45 on news of the offer.
The bidders trying to take Focus Media private comprise a group of leading private equity investors, including Carlyle Group, Citic Capital Partners, FountainVest and CDH Investments. If the deal gets shareholder approval, it will then source financing from three international investment banks.
Why would Focus Media want to go private?
In part because it has been feeling unloved by US investors and complains that its stock is undervalued.
Company executives also trot out similar complaints to those made by other Chinese firms who have opted to take the go-private path in the United States: that the privatisation process will allow them to turn away from the short-term noise and distraction of the public markets to focus on building a more profitable company over the longer term.
Focus Media’s Nasdaq IPO was launched in 2005 to widespread fanfare and within two years its shares had risen to $60 from a debut price of $17. But the stock started to lose its sheen, as sales growth slowed and investors worried that the company had overpaid for acquisitions during its growth spurt.
In November last year there was a new body blow, with the release of a stinging report from short-seller Muddy Waters (see WiC130). The allegations included the claim that Focus Media was overstating the number of screens in its digital network by more than half. Carson Block, the public face of Muddy Waters, even claimed that a chunk of the company’s digital network was made up of cardboard posters, and that it was trying to “pull a Jedi mind trick” on investors.
The company’s share price dropped by almost 40% on the same day that the allegations surfaced, although it has since recovered much of the lost ground, reporting rising quarterly profits for more than a year and dropping some of the poorest performing areas of its business.
Jiang has also fought his own corner keenly on weibo, China’s equivalent of Twitter. “The US market is so difficult to comprehend – the better a company is, the more it drops,” he complains. “Is it because our results are so good that the short-sellers are embarrassed and feel the need to spread all manner of gossip?”
In fact, the offer on the table from the consortium would return the stock to its pre-Muddy Waters price. But clearly the plan is to seek out a higher valuation elsewhere, as well as avoid much of the unwelcome attention (short-sellers included) that Chinese firms now realise comes with a US listing.
So the experience reflects wider trends for Chinese companies listed in the US?
China-concept stocks listed in America are priced at historically low levels, says CBN, a business newspaper. This follows a period when at least 200 Chinese companies floated on the New York Stock Exchange or Nasdaq, with many more coming to market through reverse takeovers (and dodging the more onerous IPO process). Many were privately-owned enterprises which found it difficult to source bank financing at home or couldn’t get approval to list on China’s domestic stock exchanges, where state-owned companies tend to push to the front of the queue.
But over the last 18 months there has been a crisis of investor confidence in these China stocks in the US, after a wave of cases of accounting fraud and accusations of weak corporate governance.
Attacks from short-sellers have darkened the mood further, although the most high profile case (Muddy Waters again, this time targeting Sino-Forest – see WiC111) was actually listed on the Toronto Exchange. With the short-sellers sensing blood in the water, many companies have been ill-prepared for the hostile environment. Some have gone to the wall or have been forcibly delisted.
As a result, deal flow has gone into reverse, as more firms talk about ridding themselves of their US domicile. A total of 19 Chinese companies delisted from American exchanges during the first half of this year, with only one successful Chinese IPO being reported in the same period, according to a report from Ernst & Young in July. At least 16 more companies are in the process of attempting to delist.
Many say that the companies only have themselves to blame for their predicament, especially those that have failed to meet regulatory requirements. But some firms complain the backlash has been undeserved. They admit that some Chinese companies haven’t met the standards expected by US investors but say that it’s unfair that a whole sector is being tarred with the same reputational brush. Valuations among the China stocks have fallen further than the market average, making new fundraising even more difficult, especially for company founders reluctant to see their ownership further diluted at lower prices.
In contrast the private equity offers look appealing (in their case too much money is chasing too few China deals, pushing up the bid prices). Ultimately both business owners and the private equity kingpins see potential for listing again in Shanghai, Shenzhen or Hong Kong, where higher valuation multiples beckon.
Who else has gone private?
The first take-private deal was in November two years ago but a series of other companies have tried to follow suit since. One of the best-known names is Shanda Interactive, which delisted from Nasdaq in February this year in a $2.3 billion deal after a takeover offer led by the company’s founder, Chen Tianqiao. At the time, Chen said he would be looking to list on a domestic Chinese stock market, perhaps the Nasdaq-style ChiNext in Shenzhen.
Before that, Harbin Electric, a maker of electric motors, had followed a similar route, delisting late last year in a $750 million sale to its own chief executive, Yang Tianfu, and private equity firm Abax Capital. It had also experienced a protracted confrontation of its own with the short-sellers. “I am tired of the US,” Yang told Bloomberg at the time. “We just couldn’t communicate with the investors.”
In June this year, Abax Capital announced another $364 million deal, this time to take copper wire manufacturer Fushi Copperweld private. Again, the company’s chief executive was in on the transaction, which was financed by China Development Bank (CDB). By mid-year, CDB had provided more than $1 billion to finance similar delisting transactions.
Are investors likely to wave the Focus Media bid through?
The go-private path can be treacherous, with the risk of lawsuits from rebel investors that feel deals are underpriced.
In Focus Media’s case, there has already been a rumpus over a spike in trading of the company’s call options in the days immediately prior to the announcement of the bid. But, overall, its prospects look solid. The financing is already in place and two of the leading shareholders seem keen to see the deal completed. Fosun Group (see WiC109), which holds a little over 17%, is supposed to be interested in the offer, having bought into the company at a huge discount to the bid price. Jiang himself, who holds 18%, is (obviously) pushing for the deal too.
What’s in it for the private equity firms?
If their calculations are right, they will be picking up Focus Media at an attractive valuation. Presumably their own due diligence has convinced them that the business is sounder than the short-sellers have insinuated.
Down the line they will then cash out. Doug Young, who publishes a blog following China-related stocks, says that a re-listing is less likely in this case than a sale to a firm like Tencent (a major internet portal) or Baidu (best known as China’s top search engine). That sounds plausible. Competition within the ‘new media’ sector is fierce as incumbents look to diversify their revenue streams and chase cross-marketing opportunities. Focus Media’s digital platform could prove of interest.
Meanwhile for Jiang a successful privatisation will give him some breathing space to refocus on the business – much more appealing, you would think, than expending his energy fighting a war of words with Muddy Waters.
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