Why did hog giantâ€™s IPO fail to entice investors?
May 2, 2014 (WiC 235)
During the worldâ€™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 Wangâ€™s properties to improve her fortune.
One of these holes â€“ about three metres wide and nine metres deep, according to the China Entrepreneur magazine â€“ 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. Wangâ€™s capital would jumpstart the firmâ€™s extraordinary transformation from a state-owned factory in Henanâ€™s Luohe city into Chinaâ€™s biggest (and privately-held) pork producer.
Seeing Shuanghuiâ€™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 Shuanghuiâ€™s chairman Wan Long (see WiC201 for a profile of the man known locally as the â€˜Steve Jobs of Chinese butcheryâ€™). His rationale was that he wanted to â€œmake full use of foreign capital, but not be controlled by itâ€. 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 Wangâ€™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 baconâ€¦
When WH applied to list on Hong Kongâ€™s stock exchange in January, the firm talked up the prospect of launching the cityâ€™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 â€œan unusually wide indicative rangeâ€ 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. WHâ€™s trading debut was pushed back by a week to May 8.
But investors remained unenthused. Blaming â€œdeteriorating market conditions and recent excessive market volatilityâ€ (the prefferred explanation for most failed IPOs), WH shelved its IPO on Tuesday.
â€œThe worldâ€™s largest pork company has gone from Easter ham to meagre spare rib,â€ the Wall Street Journal quipped.
Were rough market conditions to blame?
The failed deal was another blow for bankers in Hong Kongâ€™s equity capital markets, who have watched the planned IPO of Hutchisonâ€™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 WHâ€™s decision to postpone the listing. Hong Kongâ€™s Hang Seng index dropped 4.5% between the dealâ€™s formal launch on April 10 and its eventual withdrawal on April 29, according to the South China Morning Post. Other IPOs havenâ€™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 Chinaâ€™s slowing economy have depressed interest in Chinese assets more generally.
Nevertheless, investors were anxious about WHâ€™s investment story too and specifically whether the companyâ€™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 â€“ and boost confidence among the countryâ€™s jaded consumers â€“ the more immediate business logic was to sell Smithfieldâ€™s lower-cost meat into China, where prices at the premium end of the market are typically higher.
â€œWe 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,â€ the company said in its prospectus. â€œWe expect [this] to positively affect our turnover and profitability.â€
In recent months this strategy has faced headwinds, with prices going â€“ from the pork giantâ€™s perspective â€“ 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 itâ€™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 isnâ€™t as strong. So fund managers have needed more convincing of the value of the newly combined Shuanghui and Smithfield businesses.
So WHâ€™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 doesnâ€™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 WHâ€™s American pork business) trades at a price-to-earnings ratio of 23.
Hence China Business Journal concludes that WH priced itself as â€œnot too high and not too lowâ€ 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 arenâ€™t immediately obvious and that the new business model has hardly been tested (the Smithfield deal closed last September and exports to China didnâ€™t start until the beginning of this year). The criticism is that WH hasnâ€™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. â€œEven 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,â€ notes Reuters Breakingviews. (And letâ€™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: â€œItâ€™s like buying a house, ripping out the bathrooms and kitchen and trying to flip it for a premium six months later.â€
CBN agreed that investors have the right to be wary: â€œThe market simply has not had time to judge if there is meaningful synergy coming out of WHâ€™s units. Nor is there a single signal that WH has the ability to properly manage an American firm.â€
Why did WH want to IPO so fast?
This question brings us back to Shuanghuiâ€™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 governmentâ€™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 â€œhave waited patiently for at least eight years to exitâ€. 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 wasnâ€™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 Shuanghuiâ€™s longstanding investors.
How so? WHâ€™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 yearâ€™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. â€œThey rushed into an IPO and didnâ€™t spend time to actually create the synergy between the US and Chinese business,â€ one fund manager in Hong Kong complained to FinanceAsia this week. â€œThey 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?â€
Fuhrmanâ€™s view is much more withering: â€œI just couldnâ€™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.â€
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 companyâ€™s single largest shareholder, told the Wall Street Journal that it refuses to sell its WH shares cheaply. â€œWe have a strong belief in the businessâ€™ fundamentals and its long term value,â€ 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 Shuanghuiâ€™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 â€“ or about 5% of last yearâ€™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. â€œSome of them were too confident, and even a bit arrogant, when they tried to price the deal and coordinate with each other,â€ the source told the newspaper.
Then again, the banks will be irked by the expenses inccurred on a deal that didnâ€™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.