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WH Group Hong Kong IPO Goes Belly Up – Leaving Wall Street’s Most Famed Investment Banks and Some of Asia’s Biggest PE Firms at an Embarrassing Loss

WSJ Shuanghui WH Group failed IPO

There will be an awful lot of embarrassed financial professionals sulking around Hong Kong and Wall Street today. The reason: a crazy IPO deal financially-engineered by a group of 29 big name investment banks, led by Morgan Stanley, together with several large China and Asian-based PE firms including China’s CDH and Singapore’s Temasek Holdings failed to find investors. Their pig’s ear didn’t, as they promised, turn into the silk purse after all. The planned IPO of WH Group has been aborted.

WH Group was created by the banks and PE firms to hold the assets of American pork producer Smithfield Foods bought last year in a leveraged buyout. The other asset inside of WH Group is a majority shareholding in China’s largest pork company Henan Shuanghui Investment & Development.

I was one of the few who actually called into question almost a year ago the logic as well as the economics of the deal. You can read my original article here.

There weren’t a lot of other doubters at the time. The mainstream financial press, by and large, went along with things, accepting at face value the story provided to them by Morgan Stanley, CDH and others. Over the last few months, as the now-failed IPO got into gear in anticipation of closing the deal around now, the press kept up its steady reporting, not raising too many tough questions about what were obviously some glaring weak points – the high debt, the high valuation, the crazy corporate structure that made the deal appear to be what it wasn’t, a Chinese takeover of a big US pork company.

I have no special interest in this deal, since me and my firm never acted for any of the parties involved, nor do I own any shares in any of the companies involved. I just couldn’t get over, in reading the SEC documents filed at the time of the takeover, the brazenness of it, the chutzpah, that these big institutions seemed to be betting they could repackage a pound of sausage bought in New York for $1 as pork fillet and sell it for $5 to Hong Kong investors and institutions.

In other words, saying at the time it looked like the whole thing rested on a very shaky foundation was a reasonable conclusion for anyone who took the time to read the SEC filings. Instead, mainly what we heard about, over and over, was that this was (wrongly) China’s “biggest takeover of a US company,” a “merger between America’s largest pork producer and its counterpart in the world’s largest pork market.”

Morgan Stanley, CDH, Temasek and the others got a little too cocky. The original Smithfield “take private” deal last year went through smoothly. They moved quicker than originally planned to get the company re-listed in Hong Kong. Had they pulled it off, it would have meant huge fees for the investment bankers, and depending on the share price, a juicy return for the PE firms, most of whom had been stuck holding the shares in Henan Shuanghui Investment & Development for over seven years. First came word last week they wanted to cut back by 60% the size of the IPO due to the hostile reception from investors during the road show phase. Then the IPO was suddenly called off late on Tuesday, Hong Kong time.

One of the questions that never got properly answered is why these PE firms didn’t sell their Shuanghui shares on the Chinese stock market, but held them since IPO, without exiting. That’s unusual, especially since Shuanghui’s shares have traded well above the level CDH and others bought in at. I wasn’t in China at the time, but that original investment did not cover itself in praise and glory. Almost immediately after the PE firms went in, providing the capital to allow the state-owned Shuanghui to privatize itself in 2006, the rumors began to circulate that the deal was deeply corrupt, and for reasons never explained, was structured in a way where the PE firms did not have a way to exit through normal stock market channels.

The Smithfield acquisition never made much of any industrial sense. The PE firms that now own the majority (mainly CDH, Temasek, New Horizon, but also including Goldman Sachs’ Asia PE arm ) have no experience or knowledge how to run a pork business in the US. In fact, they don’t know how to run any business in the US. The Shuanghui China management, which is meant now to be serving two separate masters, simultaneously running the Chinese company and its troubled American cousin, similarly don’t know a hock from a snout when it comes to raising and selling pork in the US. This is, was and will remain the main business of Smithfield. Not exporting pork to China. How, when and why these US assets can be listed in Asia must certainly now count as a mystery to all of the big-name financial institutions involved, including Bank of China, which lent billions to finance the takeover last year, as did Morgan Stanley itself.

So, now we have this sorry spectacle of the PE firms, together with partners, having seemingly thrown more money away in a failed bid to rescue the original Shuanghui investment from its unexplained illiquidity. The WH Group IPO failure is also a stunning rebuke for the other PE-backed P2P take private deals now waiting to relist in Hong Kong. (Read here, here, here.) Smithfield, while no great shakes, is the jewel among the rather sorry group of mainly-Chinese companies taken private from the US stock exchange with the plan to sell them later to Hong Kong-based investors via an IPO.

This was among the most bloated IPOs ever, with 29 investment banks given underwriting mandates to sell shares. ( The IPO banks included not only Morgan Stanley, but also Citic Securities, Goldman Sachs, UBS, Barclays, Credit Suisse, JP Morgan, Nomura, Citigroup, Deutsche Bank.) All that expensive investment banking firepower. Result: among the most expensive IPO duds in history.

For the PE consortium that owns WH Group, they will have already likely lost over USD$15mn in LP money on legal, underwriting and accounting fees on this failed IPO. This is on top of a whopping $729mn fees paid by the PE firms for what are called “one-off fees and share-based payments” to acquire Smithfield. The subsequent restructuring ahead of IPO? Maybe another $100mn. If or when the WH Group IPO is tried again, the fees will likely be at least as high as the first time around. In short, the PE firms are already close to $1 billion in the red on this deal, not including interest payments on all the debt.  Smithfield itself remains lacklustre. Its net profit shrank 50% during the fiscal year leading up to the buyout.

With no IPO proceeds anywhere on the horizon, the issue looming largest now for the PE firms: is WH Group generating enough free cash to service the $7 billion in debt, including $4 billion borrowed to buy sputtering Smithfield? If not, next stop is Chapter 11.

By contrast, now feeling as delighted as pigs in muck are the mainly-US shareholders who last year sold their Smithfield shares at a 31% premium above the pre-bid price to the Chinese-led PE group. It doesn’t offset by much the US trade deficit with China, which reached a new record last year of $318 billion. But these US investors also get the satisfaction of knowing they have so far received the far better end of a deal against some of the bigger, richer financial institutions in Asia and Wall Street.

 

Pork chopped. Why did hog giant WH Group’s IPO fail to entice investors? — Week in China

week in china

Week in China cover

Pork chopped

Why did hog giant’s IPO fail to entice investors?

During the world’s biggest probate dispute a few years ago, a fascinated audience learned that Nina Wang, the late chairwoman of Hong Kong real estate developer Chinachem, paid $270 million to her feng shui adviser (and lover) to dig lucky holes. As many as 80 of them were dug around Wang’s properties to improve her fortune.

One of these holes – about three metres wide and nine metres deep, according to the China Entrepreneur magazine – was burrowed outside a meat processing plant in China.

Why so? Chinachem was the first foreign investor brought in by Shuanghui bosses in 1994 to help the abattoir expand. Wang’s capital would jumpstart the firm’s extraordinary transformation from a state-owned factory in Henan’s Luohe city into China’s biggest (and privately-held) pork producer.

Seeing Shuanghui’s potential, Wang offered to acquire its trademark and then to buy a majority stake for HK$300 million ($38 million). Both proposals were rejected outright by Shuanghui’s chairman Wan Long (see WiC201 for a profile of the man known locally as the ‘Steve Jobs of Chinese butchery’). His rationale was that he wanted to “make full use of foreign capital, but not be controlled by it”. Despite never owning a majority stake in the hog firm, he insisted on running the company his own way.

Two decades have passed since Wan first courted Nina Wang’s cash and in that time a range of new investors have bought into the company. Last year they helped Shuanghui to acquire American hog producer Smithfield for $7.1 billion (including debt) and in January the firm was renamed WH Group, ahead of a multi-billion dollar Hong Kong listing. But embarrassingly the IPO was pulled this week, as plans for the flotation went belly-up.

Not bringing home the bacon…

When WH applied to list on Hong Kong’s stock exchange in January, the firm talked up the prospect of launching the city’s biggest IPO since 2010. It kicked off the investor roadshow early last month intending to raise up to $5.3 billion. Four fifths of the total was to be used to help WH repay loans taken to finance the Smithfield takeover, with bankers setting the price between HK$8 and HK$11.25 a share. This was “an unusually wide indicative range” according to Reuters, but also a recognition of the uncertain outlook in the Hong Kong stockmarket.

A few weeks later, the 29 banks hired to promote the IPO (a record) returned with lukewarm orders. WH was forced to cleave the offer by more than half. Excluding the greenshoe allotment, the new plan was dramatically less ambitious, and looked to raise between $1.34 billion and $1.88 billion. To boost investor confidence, existing owners also dropped plans to sell some of their own shares in the listing. WH’s trading debut was pushed back by a week to May 8.

But investors remained unenthused. Blaming “deteriorating market conditions and recent excessive market volatility” (the prefferred explanation for most failed IPOs), WH shelved its IPO on Tuesday.

“The world’s largest pork company has gone from Easter ham to meagre spare rib,” the Wall Street Journal quipped.

Were rough market conditions to blame?

The failed deal was another blow for bankers in Hong Kong’s equity capital markets, who have watched the planned IPO of Hutchison’s giant retail arm AS Watson slip away and have seen Alibaba Group opt to go to market in New York instead.

Volatile markets may have contributed to WH’s decision to postpone the listing. Hong Kong’s Hang Seng index dropped 4.5% between the deal’s formal launch on April 10 and its eventual withdrawal on April 29, according to the South China Morning Post. Other IPOs haven’t been faring well recently. Japanese hotel operator Seibu Holdings and Chinese internet firm Sina Weibo both pared back share sales last month, while the Financial Times notes that concerns about China’s slowing economy have depressed interest in Chinese assets more generally.

Nevertheless, investors were anxious about WH’s investment story too and specifically whether the company’s valuation was too high.

One of the selling points of the original Shuanghui takeover of Smithfield was that it married a reputable American brand with a company that wanted to adapt best practices in product quality and food safety in China. But if one longer term goal was to improve the reputation of Chinese pork – and boost confidence among the country’s jaded consumers – the more immediate business logic was to sell Smithfield’s lower-cost meat into China, where prices at the premium end of the market are typically higher.

“We plan to leverage our US brands, raw materials and technology, our distribution and marketing capabilities in China and our combined strength in research and development to expand our range of American-style premium packaged meats products offerings in China,” the company said in its prospectus. “We expect [this] to positively affect our turnover and profitability.”

In recent months this strategy has faced headwinds, with prices going – from the pork giant’s perspective – in the wrong direction. American pig farmers are struggling with a porcine virus that has wiped out more than 10% of hog stocks. This has sent US pork to new highs, meaning it’s no longer so low-cost. In contrast, Xinhua notes that pork prices in many Chinese cities have fallen to their lowest levels in five years. As such, the commercial case for exporting US pork to China isn’t as strong. So fund managers have needed more convincing of the value of the newly combined Shuanghui and Smithfield businesses.

So WH’s valuation was too high?

Bloomberg said WH was prepared to sell its shares towards the bottom of the marketed price range, which equates to a valuation of 15 times estimated 2014 earnings.

At first glance that doesn’t look too demanding. Henan Shuanghui Investment, the Chinese unit of WH Group that is listed in Shenzhen, carries a market capitalisation of Rmb78 billion ($12.6 billion), or 20 times its 2013 net profit. Hormel, a Minnesota-based food firm that produces Spam luncheon meat (and is a key competitor for WH’s American pork business) trades at a price-to-earnings ratio of 23.

Hence China Business Journal concludes that WH priced itself as “not too high and not too low” among peers, especially if the company can generate genuine synergies between its China operation and its newly acquired American unit.

But an alternate view is that these synergies aren’t immediately obvious and that the new business model has hardly been tested (the Smithfield deal closed last September and exports to China didn’t start until the beginning of this year). The criticism is that WH hasn’t done much more than put Shuanghui Investment and Smithfield together into a holding vehicle, but is now asking for a valuation greater than the sum of the two parts. “Even at the bottom of the range, the IPO implies a valuation for Smithfield 21% above the price WH Group paid for the US pork producer barely eight months ago,” notes Reuters Breakingviews. (And let’s not forget, Smithfield was purchased at a 30% premium to its market price at the time.)

Or as one banker put it to the FT: “It’s like buying a house, ripping out the bathrooms and kitchen and trying to flip it for a premium six months later.”

CBN agreed that investors have the right to be wary: “The market simply has not had time to judge if there is meaningful synergy coming out of WH’s units. Nor is there a single signal that WH has the ability to properly manage an American firm.”

Why did WH want to IPO so fast?

This question brings us back to Shuanghui’s transformation from a state-owned enterprise to a privately-held firm. In April 2006 a consortium including Goldman Sachs and Chinese private equity funds CDH and New Horizon paid about $250 million to buy out the city government’s stake in Shuanghui.

The leveraged buyout was an unusual example of a Chinese national brand (and market leader) being snapped up by foreign buyers. Shuanghui was stripped of its SOE status, with majority ownership passing to private and foreign investors.

Century Weekly suggested last month that most of these Shuanghui shareholders “have waited patiently for at least eight years to exit”. Perhaps running low on their reserves of restraint, they then introduced the Smithfield bid last year to great fanfare as the largest takeover yet of a US company by a Chinese firm.

But as Peter Fuhrman, chairman of China First Capital, a boutique investment bank, told WiC at the time, this wasn’t really the case. In fact the bid for Smithfield was a leveraged buyout by a company based in the Cayman Islands, not a Chinese one. And its main purpose was to facilitate a future sale by Shuanghui’s longstanding investors.

How so? WH’s set-up is complex: the IPO prospectus features an ownership chart containing WH Group, Shuanghui Group and Shuanghui Investment (not to mention several dozen joint ventures and Smithfield itself). One of these entities is listed in Shenzhen, but the investor group has been looking for other ways to cash out. A key motivation in last year’s dealmaking was that they thought they had found an alternative route via a Hong Kong IPO.

And less than a year after the Smithfield bid, WH made its move, not least because it needs to reduce some of the debt incurred in buying its new American business.

But many market watchers think it looked too hasty. “They rushed into an IPO and didn’t spend time to actually create the synergy between the US and Chinese business,” one fund manager in Hong Kong complained to FinanceAsia this week. “They wanted to float the stock to fund the acquisition and also let the private equity firms exit. But if WH Group is good, then ride with me. Why should I buy when you are selling?”

Fuhrman’s view is much more withering: “I just couldn’t get over, in reading the SEC documents at the time of the takeover, the brazenness of it, the chutzpah, that these big institutions seemed to be betting they could repackage a pound of sausages bought in New York for $1 as pork fillet and sell it for $5 to investors in Hong Kong.”

And what of the boss? Wan Long and another director Yang Zhijun pocketed almost $600 million in share options between them last year after the Smithfield bid went through. (The move pushed WH into a loss in 2013.) The size of the compensation package is said to have also deterred some fund managers.

What next for WH?

Any attempt to resurrect the offering will have to wait until after its first-half results, meaning a possible return to the market in September at the earliest. There have been reports that the deal is more likely be postponed until next year. CDH, the company’s single largest shareholder, told the Wall Street Journal that it refuses to sell its WH shares cheaply. “We have a strong belief in the business’ fundamentals and its long term value,” a spokesperson insisted.

But China Business Journal says that WH now needs to focus on convincing investors that it has a good story to tell, including providing a clearer integration plan for Smithfield and Shuanghui’s operations. The pressure will also increase to find alternative ways to retire some of the debt taken on to finance the Smithfield acquisition. Reports suggest that early refinancing was expected to reduce debt repayments by around $155 million on an annualised basis – or about 5% of last year’s profit.

WH may also use the delay to rethink how it goes to market next time, with the South China Morning Post reporting that senior executives have been blaming the banks for the breakdown. “Some of them were too confident, and even a bit arrogant, when they tried to price the deal and coordinate with each other,” the source told the newspaper.

Then again, the banks will be irked by the expenses inccurred on a deal that didn’t happen. And in retrospect it looks to have been a flawed decision to mandate 29 of them. As WH has learned, it diffused responsibility and may have disincentivised some of the participants.

Indeed, another comment on the situation is that the only winners from this IPO were the airlines and hotels that were used as part of the roadshow process.

http://www.weekinchina.com/2014/05/pork-chopped/?dm

 

WH’s canceled IPO shows dangers of misjudging demand — China Daily Article

China Daily

WH’s canceled IPO shows dangers of misjudging demand

By Michael Barris (China Daily USA)

It could have been the largest IPO in a year. Instead the canceled initial offering of Chinese pork producer WH Group became an epic flop and an example of the pitfalls of failing to accurately gauge investor demand for IPOs.

Eight months ago, in the biggest-ever Chinese acquisition of a US company, WH, then known as Shuanghui International Holdings Ltd, acquired Virginia-based Smithfield Foods Inc, the world’s largest hog producer, for $4.7 billion. Awash in kudos for tapping into China’s increasing demand for high-quality pork, a Shuanghui team began working on a planned Hong Kong IPO.

By late April, however, the proposed offering was in deep trouble. Bankers slashed the deal’s marketed value to $1.9 billion from $5.3 billion. Finally, the company, now renamed WH Group, announced it would not proceed with the IPO because of “deteriorating market conditions and recent excessive market volatility”.

The decision handed the company a setback in its effort to cut the more than $2.3 billion of debt it took on in the Smithfield purchase and dealt a blow to Asia’s already struggling IPO market and the stock prices of some formerly high-flying Asian companies. The WH IPO debacle is even seen as possibly hampering the much-anticipated New York IPO of Chinese e-commerce giant Alibaba Group, expected to occur later this year and valued at an estimated $20 billion.

WH's canceled IPO shows dangers of misjudging demand

What went wrong? To put it simply, investors scoffed at the idea of paying top price for WH shares without any clear indication of how the Smithfield acquisition would save money.

The price range of HK$ 8 to HK$ 11.25 per share ($1.03 to $1.45) was at a valuation of 15 to 20.8 times forward earnings. “The synergies between Shuanghui and Smithfield are untested. Why do investors have to buy in a hurry?” Ben Kwong, associate director of Taiwanese brokerage KGI Asia Ltd, was quoted in the Wall Street Journal. “They would rather wait until the valuation is attractive.”

A disease that infected pigs, inflating US prices, also turned off investors. US pork typically trades at about half the meat’s price in China, because US feed tends to be cheaper. But Chicago hog futures have soared 47 percent this year to $1.25 a pound. Investors also saw corporate governance practices which awarded shares to two executives before the listing occurred as worrisome.

“I just couldn’t get over, in reading the SEC documents filed at the time of the takeover, the brazenness of it,” China First Capital CEO and Chairman Peter Fuhrman wrote on the Seeking Alpha investment website. “These big institutions seemed to be betting they could repackage a pound of sausage bought in New York for $1 as pork fillet and sell it for $5 to Hong Kong investors and institutions.

The Smithfield acquisition “never made much of any industrial sense”, Fuhrman wrote. The private equity firms behind WH – CDH Investments, Singapore state investor Temasek Holdings and New Horizon – “have no experience or knowledge how to run a pork business in the US. In fact, they don’t know how to run any business in the US”, he wrote.

One man’s meat, however, is another man’s poison. As Fuhrman wrote, the debacle has ended up putting smiles on the faces of the mainly-US shareholders who last year reluctantly sold their Smithfield shares at a 31 percent premium above the pre-bid price. Some of these same shareholders had protested that the Chinese company’s offer for the pork producer was too low. Ultimately, the sellers received the satisfaction of knowing they got the “far better end of a deal against some of the bigger, richer financial institutions in Asia and Wall Street,” Fuhrman wrote. And that, he said, has likely made them as delighted as pigs in muck.

 

http://usa.chinadaily.com.cn/2014-05/14/content_17508033.htm

Too Few Exits: The PE Camel Can’t Pass Through the Eye of China’s IPO Needle

The amount of capital going into private equity in China continues to surge, with over $30 billion in new capital raised in 2011. The number of private equity deals in China is also growing quickly. More money in, however, does not necessarily mean more money will come out through IPOs or other exits. In fact, on the exit side of the ledger, there is no real growth, instead probably a slight decline, as the number of domestic IPOs in China stays constant, and offshore IPOs (most notably in Hong Kong and USA) is trending down. M&A activity, the other main source of exit for PE investors,  remains puny in China. 

This poses the most important challenge to the long-term prospects for the private equity industry in China. The more capital that floods in, the larger the backlog grows of deals waiting for exit. No one has yet focused on this issue. But, it is going to become a key fact of life, and ultimately a big impediment, to the continued expansion of capital raised for investing in China. 

Here’s a way to understand the problem: there is probably now over $50 billion in capital invested in Chinese private companies, with another $50 billion at least in capital raised but not yet committed. That is enough to finance investment in around 6,500 Chinese companies, since average investment size remains around $15mn. 

At the moment, only about 250 Chinese private companies go public each year domestically. The reason is that the Chinese securities regulator, the CSRC, keeps tight control on the supply of new issues. Their goal is to keep the supply at a level that will not impact overall stock market valuations. Getting CSRC approval for an IPO is becoming more and more like the camel passing through the eye of a needle. Thousands of companies are waiting for approval, and thousands more will likely join the queue each year by submitting IPO applications to the CSRC.

Is it possible the CSRC could increase the number of IPOs of private companies? In theory, yes. But, there is no sign of that happening, especially with the stock markets now trading significantly below their all-time highs. The CSRC’s primary role is to assure the stability of China’s capital markets, not to provide a transparent and efficient mechanism for qualified firms to raise money from the stock market. 

Coinciding now with the growing backlog of companies waiting for domestic IPOs, offshore stock markets are becoming less and less hospitable for Chinese companies. In Hong Kong, it’s generally only bigger Chinese companies, with offshore shareholder structure and annual net profits of at least USD$20 million, that are most welcome.

In the US, most Chinese companies now have no possibility to go public. There is little to no investor interest. As the Wall Street Journal aptly puts it, “Investors have lost billions of dollars over the last year on Chinese reverse mergers, after some of the companies were accused of accounting fraud and exaggerating the quality and size of their assets. Shares of other Chinese companies that went public in the United States through the conventional initial public stock offering process have also been punished out of fear that the problem could be more widespread.”

Other minor stock markets still actively beckon Chinese companies to list there, including Korea, Singapore, Australia. Their problem is very low IPO price-earnings valuations, often in single digits, as low as one-tenth the level in China. As a result, IPOs in these markets are the choice for Chinese companies that truly have no other option. That creates a negative selection bias.  Bad Chinese companies go where good companies dare not tread. 

For the time being, LPs still seem willing to pour money into funds investing in China, ignoring or downplaying the issue of how and when investments made with their money will become liquid. PE firms certainly are aware of this issue. They structure their investment deals in China with a put clause that lets them exit, in most cases, by selling their shares back to the company after a certain number of years, at a guaranteed annual IRR, usually 15%-25%. That’s fine, but if, as seems likely, more and more Chinese investments exit through this route, because the statistical likelihood of an IPO continues to decline, it will drag down PE firms’ overall investment performance.

Until recently, the best-performing PE firms active in China could achieve annual IRRs of over 50%. Such returns have made it easy for the top firms like CDH, SAIF, New Horizon, and Hony to raise money. But, it may prove impossible for these firms to do as well with new money as they did with the old. 

These good firms generally have the highest success rates in getting their deals approved for domestic IPO. That will likely continue. But, with so many more deals being done, both by these good firms as well as the hundreds of other newly-established Renminbi firms, the percentage of IPO exits for even the best PE firms seems certain to decline. 

When I discuss this with PE partners, the usual answer is they expect exits through M&A to increase significantly. After all, this is now the main exit route for PE and VC deals done in the US and Europe. I do agree that the percentage of Chinese PE deals achieving exit through M&A will increase from the current level. It could barely be any lower than it is now.

But, there are significant obstacles to taking the M&A exit route in China, from a shortage of domestic buyers with cash or shares to use as currency, to regulatory issues, and above all the fact many of the best private companies in China are founded, run and majority-owned by a single highly-talented entrepreneur. If he or she sells out in M&A deal,  the new owners will have a very hard time doing as well as the old owners did. So, even where there are willing sellers, the number of interested buyers in an M&A deal will always be few. 

Measured by new capital raised and investment results achieved, China’s private equity industry has grown a position of global leadership in less than a decade. There is still no shortage of great companies eager for capital, and willing to sell shares at prices highly appealing to PE investors. But, unless something is done to increase significantly the number of PE exits every year,  the PE industry in China must eventually contract. That will have very broad consequences not just for Chinese entrepreneurs eager for expansion capital and liquidity for their shares, but also for hundreds of millions of Chinese, Americans and Europeans whose pension funds have money now invested in Chinese PE. Their retirements will be a little less comfortable if, as seems likely,  a diminishing number of the investments made in Chinese companies have a big IPO payday.