The Ambow Massacre — Baring Private Equity Fails in Its Take Private Plan

 

In the last two years, more than 40 US-listed Chinese companies have announced plans to delist in “take private” deals.  About half the deals have a PE firm at the center of things, providing some of the capital and most of the intellectual and strategic firepower. The PE firms argue that the US stock market has badly misunderstood, and so deeply undervalued these Chinese companies. The PE firms confidently boast they are buying into great businesses at fire sale prices.

The PE firm teams up with the company’s owner to buy out public shareholders, with the plan being at some future point to either sell the business or relist it outside the US. At the moment, PE firms are involved in take private deals worth about $5 billion. Some of the bigger names include Focus Media, 7 Days Inn, Simcere Pharmaceutical.

The ranks of “take private” deals fell by one yesterday. PE firm Baring Private Equity announced it is dropping its plan to take private a Chinese company called Ambow Education Holding listed on the New York Stock Exchange. Baring, which is among the larger Asia-headquartered private equity firms, with over $5 billion under management,  first announced its intention to take Ambow private on March 15. Within eleven days, Baring was forced to scrap the whole plan. Here’s how Baring put it in the official letter it sent to Ambow and disclosed on the SEC website, “In the ten days since we submitted the Proposal, three of the four independent Directors and the Company’s auditors have resigned, and the Company’s ADSs have been suspended from trading on the NYSE. As a result of these unexpected events, we have concluded that it is not possible for us to proceed with the Transaction as set forth in our Proposal.”

Baring’s original proposal offered Ambow shareholders $1.46 a share, a 45% premium over the price at the time. Baring is already a shareholder of Ambow, holding about 10% of the equity. It bought the shares earlier this year.  Assuming the shares do start trading again, Baring is likely sitting on a paper loss of around $8mn on the Ambow shares it owns, as well as a fair bit of egg on its face. Uncounted is the amount in legal fees, to say nothing of Baring’s own time, that was squandered on this deal. My guess is, this is hardly what Baring’s LPs would want their money being spent on.

Perhaps the only consolation for Baring is that this mess exploded before it completed the planned takeover of the company. But, still, my question, “what did Baring know about any big problems inside Ambow when it tabled its offer ten days ago?” If the answer is “nothing”, well what does that say about the quality of the PE firm’s due diligence and deal-making prowess? How can you go public with an offer that values Ambow at $105 million and only eleven days later have to abandon the bid because of chaos, and perhaps fraud, inside the target company?

It is so easy, so attractive,  to think you can do deals based largely on work you can do on a Bloomberg terminal. Just four steps are all that’s needed. Download the stock chart? Check. Read the latest SEC filings, including financial statements? Check. Discover a share trading at a fraction of book value? Check. Contact the company owner and say you want to become his partner and buy out all his foolish and know-nothing US shareholders? Check. All set. You can now launch your bid.

Here the stock chart for Ambow since it went public on the NYSE:

 

 

So, in a little more than two years, Ambow’s market cap has fallen by 92%, from a high of over $1 billion, to the current level of less than $90mn. That’s not a lot higher than the company’s announced 2011 EBITDA of $54mn, and about equal to the total cash Ambow claimed, in its most recent annual report filed with the SEC, it had in the bank. Now really, who wouldn’t want to buy a company trading at 1.5X trailing EBITDA and 1X cash?

Well, start with the fact that it now looks like those numbers might not be everything they purport to be. That would be the logical inference from the fact that the company’s auditors and three of its board members all resigned en masse.

That gets to the heart of the real problem with these “PtP” (public to private) deals involving US-listed Chinese companies. The PE firms seem to operate on the assumption that the numbers reported to the SEC are genuine, and therefore that these companies’ shares are all trading at huge discounts to their intrinsic worth. Well, maybe not. Also, maybe US shareholders are not quite as dumb as some of the deal-makers here would like to believe. From the little we know about the situation in Ambow, it looks like, if anything, the US capital market was actually being too generous towards the company, even as it marked down the share price by over 90%.

A share price represents the considered assessment of millions of people, in real time. Some of those people (suppliers, competitors, friends of the auditor) will always know more than you about what the real situation is inside a company. Yes, sometimes share prices can overshoot and render too harsh a judgment on a company’s value. But, that’s assuming the numbers reported to the SEC are all kosher.  If we’ve learned anything in these last two years it’s that assuming a Chinese company’s SEC financial statement is free of fraud and gross inaccuracy is, at best, a gamble. There simply is no way a PE firm can get complete comfort, before committing to taking over one of these Chinese businesses listed in the US, that there are no serious dangers lurking within. Reputation risk, litigation risk, exit risk — these too are very prominent in all PtP deals.

Some of the other announced PtP deals are using borrowed money, along with some cash from PE firms, to pay off existing shareholders. In such cases, the risk for the PE fund is obviously lower. If the Chinese company genuinely has the free cash to service the debt, well, then once the debt is paid off, the PE firm will end up owning a big chunk of a company without having tied up a lot of cash.  Do the banks in these cases really know the situation inside these often-opaque Chinese companies? Is the cash flow on the P&L the same cash flow that passes through its hands each month?

There’s much else that strikes me as questionable about the logic of doing these PtP, or delist-relist deals. For one thing, it seems increasingly unlikely that these businesses will be able to relist, anytime in the next three to five years, in Hong Kong or China. I’ve yet to hear a credible plan from the PE firms I’ve talked to about how they intend to achieve ultimate exit. But, mainly, my concerns have been about the rigor and care that goes into the crafting of these deals. Those concerns seem warranted in my opinion, based on this 11-day debacle with Baring and Ambow.

Some of the Chinese-listed companies fell out of favor for the good reason that they are dubious businesses, run with shoddy and opaque practices, by bosses who’ve shown scant regard for the letter and spirit of the securities laws of the US. Are these really the kind of people PE funds should consider going into business with?–

 

Correction: I see now Barings actually has owned some Ambow shares for longer, and so is likely sitting on far larger losses on this position. This raises still more starkly the issue of how it could have put so much of its LPs money at risk on a deal like this, upfront, and without having sufficient transparency into the true situation at the company. This looks more like stock speculation gone terribly wrong, not private equity.

Addition: Three other large, famous institutional investors also all piled into Ambow in the months before Baring made its bid. Fidelity, GIC and Capital Group reported owning 8.76%, 5.2% and 7.4% respectively, or a total of 21.3% of the equity. They might have made a quick buck had the Baring buyout gone forward. Now, they may end up stranded, sitting on large positions in a distressed stock with no real liquidity and perhaps nowhere to go but down.