AsiaInfo-Linkage

China M&A: Three Recent Deals

In the last month, three large takeovers were announced involving Chinese companies. In two of these, PE buyout firms (CITIC Capital and Blackstone)  are offering to take private Chinese companies (AsiaInfo-Linkage and Pactera) quoted on the US stock exchange. In the third, a Chinese acquirer (Shuanghui International) has offered to purchase all shares of US pork producer Smithfield Foods.

I’ve done a quick comparison of these deals across a range of financial variables — premium offered to current shareholders, p/e ratio, profit growth, last two years’ share price performance. I’ve also offered my own judgment on the risks and the industrial logic of the deal, on a scale of 1-10.

The results: the troubled deals, the ones with the highest risks and deepest uncertainties about future performance, with the most anemic share prices up to the date of the offer, with claims or investigations of accounting fraud, with the least industrial logic, are commanding the higher price.

Ah, the Mysterious Orient.

 

Correction: I wrote this article based on the first day’s English-language media coverage of the Smithfield-Shuanghui International takeover. Big mistake. I took at face value the media’s account that this was a merger between China’s largest pork producer and America’s. Turns out the coverage was wrong, and so my conclusion was also. In the software business, it’s called GIGO, “Garbage in, garbage out.” The Smithfield-Shuanghui deal is every bit as precarious an LBO as the other two. The only improvement is that the target company, Smithfield, is a better and more transparent business than AsianInfo-Linkage or Pactera. For the real situation on this Smithfield deal, see this blog post.

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Blackstone Leads Latest Chinese Privatization Bid — New York Times

NYT

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MAY 21, 2013, 7:07 AM

Blackstone Leads Latest Chinese Privatization Bid

By NEIL GOUGH

A fund run by the Blackstone Group is leading a $662.3 million bid for a technology outsourcing firm based in China, the latest example of a modest boom among buyout shops backing the privatization of Chinese companies listed in the United States.

A consortium backed by a private equity fund of Blackstone that includes the Chinese company’s management said on Monday that it would offer $7.50 a share to acquire Pactera Technology International, which is based in Beijing and listed on Nasdaq.

The offer, described as preliminary, represents a hefty 43 percent premium to Pactera’s most recent share price before the deal was announced. The news sent the company’s stock up 30.6 percent on Monday, to $6.87 — still more than 8 percent below the offer price, in a sign that some investors remain wary that a deal will be completed.

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Pactera ‘Challenged By Investors Every Day’ — Wall Street Journal

WSJ

By Paul Mozur

In an interview with The Wall Street Journal  on May 10th,  the chief executive of China’s largest software outsourcing company Pactera Inc. PACT -1.04% said investors had been pestering the company “every day” to carry out share buybacks to bolster the company’s share price.

“Our shares are trading very badly, it’s at a multiple that I can’t even imagine,” CEO Tiak Koon Loh said during the interview.

Since that interview, Mr. Loh, along with Blackstone Inc. BX -0.58% and several other Pactera executives, decided to try to cash in on that low price with a bid to take the company private for $7.50 a share or a 42.5% premium to where shares closed Friday on the Nasdaq Stock Market NDAQ -0.19%.

Following on the heels of a bid by a CITIC Capital Partners-led consortium to take private another Chinese IT services company AsiaInfo-Linkage Inc. ASIA -0.17%, the Pactera deal has led bankers and commentators to wonder whether the recent trend of private equity firms jumping to take Chinese companies listed in the U.S. private  is looking a little frothy.

“The [Pactera] deal may go down in the annals of most expensive [leveraged buyouts] ever launched. Blackstone is offering current shareholders a price equal to over 200 times 2012 net income,” said Peter Fuhrman, chairman of China First Capital.

Nonetheless, in the interview before the deal, Mr. Loh laid out his reasoning for why Pactera has good growth potential ahead of it. In particular, he said the company stands to benefit over the next decade, not just in the industry of software outsourcing, but also in tech consulting services as China’s technology industry booms.

For example, Pactera partnered with Microsoft Corp. MSFT -1.33% and 21Vianet Group Inc. to help develop Windows and Office cloud services in China, which launched on Wednesday.  Mr. Loh said that the company has a number of other cloud projects it is working on, in particular helping provincial governments build cloud infrastructure.

“China has always grown faster than the global [outsourcing] market,” Mr. Loh said.

But there are reasons to be more bearish on Pactera, especially in the short term. With more than 10% of its revenues coming from Japan, the company is likely to be hit hard this year by the falling Yen, according to Mr. Loh.

“Everything you do is in Japanese Yen, and every contract is signed in Japanese Yen, and it has just dropped 25%,” he said, adding that business has grown despite recent political difficulties between China and Japan.

Another issue is integration. Pactera was formed by the 2012 merger of HiSoft Technology International Ltd. and VanceInfo Technologies Inc. Mr. Loh acknowledged that there had been some “leakage” of productivity as the two companies work to integrate cultures and some employees or teams had left, but he nonetheless said that he expected growth to return.

“But beyond this year and getting back to the norm we should see ourselves growing…. no less than the industry and no less than the industry is at least 16% [revenue growth] year on year,” he said.

More than just saying it, Mr. Loh is betting on it. Now it’s a matter of whether shareholders believe that kind of growth in the coming years could get them more than the $7.5 per share on offer from the deal.

Blackstone did not immediately return calls.

CITIC Capital’s Take Private Deal for AsiaInfo-Linkage: Is This The Chinese Way to Do an LBO?

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?

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