WH Group under scrutiny in wake of cancelled Hong Kong IPO
WH Group’s ditched Hong Kong listing has drawn fresh scrutiny over the structure and rationale behind its $7bn takeover of Smithfield Foods – the largest ever US acquisition by a Chinese company.
The Sino-US pork producer, now the leader in both markets, abandoned its planned initial public offering this week, having failed to win over investors – despite alreadycutting the deal size in half.
WH Group – formerly known as Shuanghui International – blamed deteriorating market conditions, while analysts pointed to poor sentiment towards China and the outbreak of a deadly pig virus in the US.
Though investors did show interest, many were “simply not on the same page as the company” when it came to valuation, said one person with knowledge of the sale process.
However, some have raised doubts over WH Group’s longer-term prospects, and questioned the thinking behind the Smithfield buy. WH Group had pitched itself as a global leader tapping rising Chinese consumption, but investors instead responded to two separate businesses – one in the US and one in China – bolted together and creaking with debt, say bankers.
“It’s like buying a house, ripping out the bathrooms and kitchen, and trying to flip it for a premium six months later,” said one senior equity banker.
Investors also expressed concerns that a trimmed deal would simply store up trouble down the road, by raising only a slice of the money needed to pay off debts. Further capital raising and shareholder sales would then be inevitable – creating a major overhang for a company seeking a valuation in line with established US peers.
The original case for purchasing Smithfield was to create one international company that could capitalise on cheap pork in the US by selling it into China, the world’s biggest consumer of the meat. Smithfield’s higher-margin pork products – such as ham and sausages – were also seen as a neat way to gain exposure to rising wealth and changing eating habits in China.
When announcing the deal in September last year, Wan Long, now chairman of WH Group, pointed to numerous advantages of combining the companies.
“Together we look forward to utilising our individual strengths – including Shuanghui’s extensive distribution network in China, and Smithfield’s leading production and safety protocols – to provide safe, high-quality products to consumers worldwide,” he said at the time.
But the company has yet to prove to investors that its plans will work, having completed the takeover only six months before attempting to list. Management has not yet been integrated, while Smithfield products are still some months away from arriving on Chinese supermarket shelves.
WH Group borrowed about $4bn to finance its purchase of Smithfield, much of which is not due to be repaid for years. Most of it was lent by Bank of China, although a chunk of about $1.5bn – originally a bridge loan from Morgan Stanley – has now been placed with US investors as five-year and seven-year debt. The company had sought a listing to help pay off some of its loans, largely because of the chairman’s own distrust of debt, according to two people with knowledge of the process.
Though the debt was borrowed at relatively cheap rates, the failure to attract new equity investment leaves the company with tens of millions of dollars a year of debt-servicing costs, and leaves private equity investors trapped for the foreseeable future.
Peter Fuhrman, chief executive of advisory firm China First Capital, describes the episode as one of the “most expensive IPO duds in history”, and believes the Smithfield deal was actually an attempt by private equity investors to bulk up the company to help provide an exit to their holdings in the original China-only business.
Those investors include Goldman Sachs, Temasek and New Horizon. However, CDH Investments, a Chinese private equity house, is by far the largest outside shareholder, and thought to have been a key driving force behind the deal.
“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,” Mr Fuhrman wrote on his blog. “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.”
Those familiar with the cancelled float say that WH Group is almost certain to return at a later date, with a new deal likely to involve a far smaller syndicate than the 29 bookrunners it hired first time round.
Attention will now shift to the company’s first-half earnings. Last year WH Group made a net loss of $67m, largely caused by share-based awards given to two executives worth almost $600m, according to its listing prospectus. Shares in the Chinese business – listed in Shenzhen under the name Henan Shuanghui Investment & Development – are down by a quarter so far this year.
Why did hog giant’s IPO fail to entice investors?
May 2, 2014 (WiC 235)
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.
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 $20 billion.
What went wrong? To put it simply, investors scoffed at the idea of paying top price for WH shares without any clear indication of how the Smithfield acquisition would save money.
The price range of HK$ 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.