Buying the family firm

Investment rule number one: only put money into things that you understand. Rule two: when the market gets tough, stick even more strictly to rule number one.

The assets that most business tycoons are most familiar with are the shares of their own companies. That’s why when Hong Kong stocks dropped to historical lows during the deadly SARS outbreak in late 2002 and early 2003, most of the richest real estate tycoons in the territory smelt an opportunity. Numerous buyouts or restructuring efforts were offered against their listed property units.

In the biggest and most controversial deal Henderson Land tried taking its investment holdings firm Henderson Investment (HI) private for about HK$5.5 billion ($707 million). HI sat on a hefty property portfolio, including the residence of the group’s own chairman, as well as a 36% stake in HK & China Gas, Hong Kong’s de facto gas monopoly. The latter stake alone was worth HK$21.9 billion at the time – and HK$86 billion as of this week.

The offer was deemed too low by minority shareholders, who vetoed the deal. But many of the other buyout attempts were successful. As the SARS outbreak subsided in the summer of 2003, the stock market rebounded strongly. Hong Kong’s real estate shook off six years of deflation and headed into a 17-year bull market.

As Covid-19 has sent stockmarkets into meltdown this year, another flurry of go-private proposals has been made in Hong Kong. Who is involved and does it portend another buying opportunity?

What offers have been tabled?

Elec & Eltek, a circuit board maker with three major production lines in China, was the latest target last Friday. Its parent firm Kingboard made a similar attempt during the 2009 global financial crisis, although it was eventually rejected by other shareholders. Now it’s trying again for the company’s Hong Kong- and Singapore-listed shares, which were worth about $380 million as of Wednesday.

Just a few days earlier, Clear Media, the largest operator of bus shelter advertising in China, said it had received a buyout offer from investors led by its chief executive Han Zijing.

Valued at HK$3.9 billion, Han’s MBO consortium (in which he has a stake of 40%) is backed by Ant Financial (30%), the sister firm of Chinese internet giant Alibaba, JCDecaux (23%), one of the largest outdoor advertising providers, and the China Growth Wealth Fund (7%).

There are much bigger deals on the table. In another example, the iconic merchandising firm Li & Fung said it had received a HK$7.2 billion delisting offer from the Fung family, which has been running the company for more than a century.

The founding shareholder now owns about 32% of Li & Fung and its buyout attempt is backed by GLP, a logistics developer and fund manager with more than $89 billion in assets.

Last but not least, in late February Wheelock said the family of its former chairman Peter Woo had offered to take private the 30% stake in the property firm that it doesn’t already own. The cash-and-stock deal is valued at more than HK$15 billion.

Are the families at Hong Kong’s blue-chips feeling unloved?

Peter Woo is the son-in-law of YK Pao, the shipping magnate who took over Wheelock and Wharf, formerly two of the biggest British trading houses (or hongs) in Hong Kong.

Pao made his move when talks about the British colony’s return to China were shaking investor confidence in the late 1970s.

The Fung family is another of the most powerful clans in the territory. Both Wheelock and Li & Fung, the Hong Kong Economic Times notes, are former blue-chips but these “old-school Hong Kong stocks” have been out of favour.

Investors have been switching instead to “new economy” counters such as the “ATM trio” of Alibaba, Tencent and Meituan-Dianping – three of the biggest Chinese internet firms, which are also listed on the Hong Kong bourse.

Li & Fung was founded in 1906 in Guangzhou, serving as a comprador for European clients. In more recent times, especially in the years following China’s joining of the World Trade Organisation, it earned top billing as the ultimate middleman between American brands (such as Walmart) and their Asian supply chains. The company was worth more than HK$200 billion back in 2011 but its market value had dwindled to less than HK$5 billion before the Fung family made its buyout attempt public.

The biggest driver in Li & Fung’s downgrading, says Bloomberg’s columnist Nisha Gopalan, is the rise of e-commerce and especially Alibaba, which is connecting Chinese producers with overseas buyers directly. Thus the need for the middleman services offered by Li & Fung has been obviated.

Don’t rule out the Fungs, however. They have taken Li & Fung private before – two years after the 1987 stock market crash. The trading firm then went back to the market again in 1992 at a much higher valuation.

Other local stalwarts went through a similar exercise, like the South China Morning Post, the leading English-language newspaper in Hong Kong, which was taken private by Rupert Murdoch’s News Corp in 1987 before going public again three years later.

When market conditions improve, it’s entirely possible that Li & Fung’s assets could be repackaged into a new listing entity. If it becomes privately-held again this year the Fungs will have greater freedom to restructure the business.

The key shareholders of GLP, the co-financier in the deal, are all closely linked to mainland Chinese interests such as Vanke and Bank of China, noted Apple Daily. As such, the Fung family could be paving the way to an outright sale to “red capital” by taking the firm private, the newspaper observed.

Is the real estate sector going to be a key target again?

While the go-private spree in Hong Kong nearly two decades ago focused mostly on undervalued property firms, the conversations this time are about a more diverse mix of assets. Many of the targets still come with some property assets, however.

Li & Fung’s logistics unit LF Logistic manages 26 million square feet of warehouse and logistics space in Asia, for example. Logistics-related properties are sought-after assets in China. When Temasek invested $300 million in a 21.7% stake in LF Logistic last year, the Singapore sovereign wealth fund was valuing Li & Fung’s crown jewel at HK$10.8 billion, or twice the value of its parent firm at the time.

There are hidden property assets on Elec & Eltek’s books too. The company operates three large production sites in China (and one more in Thailand). Its parent firm Kingboard has already made moves as a purer property play by redeveloping some of its former factory sites into residential and commercial projects.

The market correction in the last few weeks has also pushed the shares of many property firms further below their net asset values (NAV). SOHO China, for instance, was trading at a discount of about 60% to its Rmb36 billion ($5.1 billion) NAV before announcing that it had received a buyout offer from an independent entity last month (Reuters has reported that the suitor is Blackstone; see WiC487).

Similarly, Wheelock was trading at HK$47.25 a share before the Woo family announced its buyout bid. That was a hefty 63% discount to the property conglomerate’s NAV at HK$129 per share as of last June.

Are the go-private bids a sign that the market is bottoming out?

At one point during the SARS outbreak in 2003, the number of listed firms being taken private in Hong Kong outnumbered the candidates for IPOs. That’s yet to be repeated this year but a trend seems to be forming in which controlling shareholders see value in their companies that the wider market is no longer recognising.

Wheelock said its take-private decision had been driven by a “historical holding company discount” (a market capitalisation well below the sum of its assets), which is fairly typical for Hong Kong’s investment holding firms or conglomerates.

But the Covid-19 crisis may have opened up opportunities for bigger bargain-hunting. The benchmark Hang Seng Index (HSI) has dropped about a fifth so far this year, a milder correction than the meltdown on Wall Street. But the sell-off had still dragged the HSI below book value in mid-March to a level that’s been seen only three times since 1993, according to Bloomberg.

This kind of decline was more than enough to alert majority owners and trigger the interest of M&A bankers. Announced take-private and buyout offers for Hong Kong-listed firms have topped $7.3 billion so far in 2020, Bloomberg says. There were 23 take-private deals worth $14.6 billion during the same period across Asia-Pacific, Dealogic also notes, compared with just seven transactions worth $297 million a year ago.

“The pace this year is matching that seen when stocks slumped during the SARS outbreak in 2003,” a local banker told the South China Morning Post.

Are mainland Chinese firms hunting for bargains as well?

It’s not only the Hong Kong tycoons who are trying to take advantage of a weak stock market, with state-owned nuclear giant China General Nuclear (CGN) announcing in late February that it wanted to delist its renewable energy unit CGN New Energy. CGN is valuing the Hong Kong-listed unit at about HK$7 billion, or nearly 50% higher than its pre-deal market value.

In fact CGN is the fifth state-owned power firm from China to offer to take its renewable energy unit off the Hong Kong bourse. Huaneng, China Power and Harbin Energy have all attempted a similar manoeuvre over the last 12 months. (Wind power firm China Longyuan and Datang Renewable Energy are the other two counters in the sector.)

Huaneng explained in a stock exchange circular that its renewable energy business had not been able to raise additional capital in Hong Kong since August 2018 as its shares were trading below NAV. On this basis it didn’t see the point of keeping the unit public.

Some of China’s other SOEs also seem likely to call it a day on the Hong Kong bourse and head home for a relisting on the A-share market, hoping for a higher valuation.

According to the Securities Times, 12 Chinese firms tabled delisting offers in Hong Kong in 2019, a 20% increase from 2018. The number of departures is set to increase this year, the newspaper said, citing projections from investment bankers in mainland China.

There was some more encouraging news for the Hong Kong bourse, though. A group of Chinese firms that completed IPOs in the US are now said to be interested in secondary offerings closer to home. The biggest fish, of course, is Alibaba, which went public in Hong Kong in a $12.9 billion offering last year (see WiC476).

Alibaba’s e-commerce rival JD.com is reportedly planning to list in Hong Kong in the first half of this year too (see WiC488).

A wave of delistings of smaller firms is likely to hit Wall Street too if investors lose confidence in Chinese companies on American bourses, the Securities Times said this week. Scandals like the financial misbehaviour at Chinese coffee chain Luckin Coffee (see this week’s “China Consumer”) may drive the trend. Similar situations in the past have seen controlling shareholders give up on the American markets, frustrated by the limited opportunities for fundraising.

“The flurry of ‘China-concept stocks’ delisting from the US in 2015 to 2016 could repeat itself as part of another confidence crisis,” the Securities Times believes.

Back in Hong Kong others will be wondering whether the smart money is sending a signal that the market slump is over and that insider shareholders are now positioning themselves for a rebound in asset values when another round of quantitative easing and economic stimulus kicks in.

Many of these families have ridden out similar crises before and profited handsomely in the aftermath. The question is whether this time could be different, with plenty of predictions that the economic impact of the coronavirus is going to be catastrophic, even rivalling the Depression of the 1930s. But Hong Kong’s Chinese tycoons – some of the savviest long-term investors in the world – seem to be saying something different…

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