Are we seeing the birth of “Leveraged Buyouts With Chinese Characteristics”? Or just some of the craziest, riskiest and unlikeliest buyout deals in worldwide history? That’s the question posed by the announcement this week that China buyout PE firm CITIC Capital Partners is leading the “take private” deal of NASDAQ-listed AsiaInfo-Linkage Inc., a Chinese software and telecommunications services that company whose shares have halved in value from over $20 during the last two years.
CITIC Capital first disclosed in January 2012 its intention to buy out the AsiaInfo-Linkage public shareholders. At the time, the share price was around $7. The board set up a committee to search for alternative buyers. It seems to have found none, and accepted this week CITIC’s offer to pay $12 a share, or 50% above the price on the day in January 2012 when it first notified the company of its interest. That seemed a rich premium 17 months ago. It seems no less so now.
Rule Number One in LBOs: do not pay any more than you absolutely need to acquire a majority of the shares. Few are the M&A deals where a premium of +50% is offered. Fewer still when the target company is one where the stock has been seriously battered for many years now. The share price went into something like a free fall in early 2010, from a high of $30 to reach that level of $7 when CITIC Capital first announced its move.
CITIC Capital is buying AsiaInfo-Linkage at a price that equates to well over 20 times its 2012 earnings. That sort of p/e multiple is rarely seen in buyout deals. Dell’s buyout is priced at half that level, or a p/e of 10X, and a premium of 25% above the share price the day before rumors about the “take private” deal started to spread.
It’s one of the exquisite oddities of this current craze to take Chinese companies private that PE firms are willing to pay p/e multiples to buy distressed quoted companies from US investors that are at least twice what the same PE firms generally say they will pay for a perfectly-healthy private Chinese company located in China. If anything, the reverse should be true.
Rule Number Two in LBOs: have a clear, credible plan to turn around the company to improve its performance and then look to sell out in a few years time. In this case, again, it seems far from obvious what can be done to improve things at AsiaInfo-Linkage and even more so, how and when CITIC Capital will exit. To complete the $900mn buyout, CITIC Capital will borrow $300mn. The interest payments on that debt are likely to chew up most of the company’s free cash, leaving nothing much to pay back principal. Sell off the fixed assets? Hard to see that working. Meantime, if you fail to pay back the principal within a reasonable period of time (say three to four years), the chances of exiting at a significant profit either through an IPO or a trade sale are substantially lower.
Leverage is a wonderful thing. In theory, it lets a buyout shop take control of a company while putting only a sliver of its own money at risk. You then want to use the company’s current free cash flow to pay off the debt and when you do, voila, you end up owning the whole thing for a fraction of its total purchase price.
In CITIC Capital’s case, I know they are especially enamored of leverage. They were formed specifically for the purpose of doing buyout deals in China. Problem is, you can’t use bank money for any part of a takeover of a domestic Chinese company. (AsiaInfo-Linkage is a rarity, a Chinese company that got started in the US over twenty years ago, and eventually shifted its headquarters to China. It is legally a Delaware corporation. This means CITIC Capital can borrow money to take it over.)
I met earlier this year with a now ex-partner at CITIC Capital who explained that the company’s attempts to do buyout deals in China have frequently run into a significant roadblock. Because CITIC Capital can’t borrow money for domestic takeovers, the only way it can make money, after taking control, is to make sure the company keeps growing at a high rate, and then hope to sell out at a high enough p/e multiple to earn a reasonable profit. In other words, a buyout without the leverage.
CITIC Capital is run mainly, as far as I can tell, by a bunch of MBAs and financial types, not operations guys who actually know how to run a business and improve it from the ground up. Sure, they can hire an outside team of managers to run a company once they take it over. But, in China, that’s never easy. Also, without the benefits of being able to leverage up the balance sheet, the risks and potential returns begin to look less than intoxicating.
We understand from insiders CITIC Capital’s plan is to relist AsiaInfo in Hong Kong or Shanghai within three years. Let’s see how that plays out. But, I’d rate the probability at around 0.5%. The backlog for IPOs in both markets is huge, and populated by Chinese companies with far cleaner history and none of the manifest problems of AsiaInfo.
AsiaInfo’s balance sheet claims there’s a lot of cash inside the company. But, we also understand it took many long months and a lot of “No’s” to find any banks willing to lend against the company’s assets and cash flow. In the end, the main lenders turned out to be a group of rather unknown Asian banks, along with a chunk from China’s ICBC. The equity piece is around 60% of total financing, high by typical LBO standards.
AsiaInfo-Linkage is in most ways quite similar to “take private Chinese company” Ptp deals of the kind I’ve written about recently, here and here. It has the same manifold risks as the other 20 deals now underway — most notably, you walk a legal minefield, can only perform limited due diligence, spend huge sums to buy out existing shareholders rather than fixing what’s wrong in the company, and so end up paying a big price to buy a company that US investors have decided is a dog.
One good thing is that AsiaInfo-Linkage hasn’t been specifically targeted either by the SEC or short-sellers for alleged accounting irregularities. This isn’t the case with the other take private deal CITIC Capital is now involved with. It’s part of the consortium taking private the Chinese advertising company Focus Media, where a lot of questions have been raised about the quality and accuracy of the company’s SEC financial statements.
AsiaInfo-Linkage seems to be a decent enough company. It is growing. Its main problem is that it relies on three mammoth Chinese SOEs — China Mobile, China Telecom, China Unicom — for over 95% of its revenues. The company’s founder and chairman, Edward Tian, is backing the CITIC Capital deal. Along with CITIC Capital, two other PE firms, Singapore government’s Temasek Holdings and China Broadband Capital Partners (where Tian serves as chairman) are contributing the approximately $400mn in cash to buyout the public shareholders and take control.
Interestingly, Edward Tian has for seven years been a “senior advisor” to Kohlberg Kravis Roberts, aka KKR, perhaps the world’s leading buyout firm. In theory, that should have put KKR in a prime position to do a deal like this — they have far more capital and experience doing buyouts than CITIC Capital, and they are already very familiar with the boss. But, they kept their wallet closed.
Disclosure: I’m a big believer in the value of doing control deals for Chinese companies. We’re just completing a research and strategy report on this area and we expect to share it soon. But, the deals we like are for the best private Chinese companies where the current PE firm investor needs to find a way to sell out before the expiry of its fund life. Such deals have their complexity, and using leverage will not be an option in most.
But, these good assets could most likely be bought at half the price (on a p/e basis) that CITIC Capital is paying to a company that shows little prospect of being able quickly to pay off in full the money CITIC is borrowing to buy it. If that happens, CITIC Capital may be lucky to get its LPs’ money back. Is CITIC Capital perhaps trying a little too hard to prove LBOs in China have their own inscrutable Chinese logic that it alone fully understands?