China take-private wave continues despite A-share crash

This article originally appeared in International Financial Law Review


Companies such as so-called flirting app owner Momo – which only listed in December 2014 – have received management buyout offers. Other companies that have received offers include Qihoo 360, which, with a $10.06 billion offer, would be the largest Chinese take-private so far.

The recent A-share crash is unlikely to halt all these deals. While they are based on the high valuations that these companies would receive in the domestic markets, some of these companies are also seeking regulatory certainty.

And while the A-share valuations helped, lengthy deal timelines meant that founders would struggle to take advantage of record highs immediately. "If you're doing a take-private now, it is unlikely that you can finish it in two weeks and immediately relist in the A-share market," said Stephanie Tang, partner at Shearman & Sterling in Hong Kong who is advising both Momo and Mindray's special committees on their take-private offers.

"It takes time," she said. "The take-private itself normally takes a minimum of four to six months to finish."

What's changed

This wave of take-privates have different reasons to those that delisted from 2011 to 2014. That group were taken private due to low valuations following short-seller attacks and concerns around accounting standards and corporate governance.

Those deals included Focus Media, 7 Days and Giant Interactive. They tended to be management buyouts with significant private equity sponsor support, and it was believed that most companies planned to relist in Hong Kong; 3SBio completed its initial public offering (IPO) last month.

These deals, on the other hand, were driven by the A-share market reaching record highs. "The price to earnings multiples were substantially higher in China, and companies looked at those multiples and wondered why they dealt with regulatory hassles and a lack of investors and liquidity when they could be getting substantially higher multiples at home," said Doug Freeman, partner at Paul Hastings in Hong Kong, who acted for the sponsors in Focus Media's 2013 take-private.

A flurry of take-privates has been announced. On July 9 video streaming operator YY and ecommerce company DangDang received management buyout offers. Other companies that have received offers include medical device maker Mindray Medical, mobile internet service provider Sungy Mobile and cord blood services company China Cord Blood.

So far these deals have been dominated by Chinese entities; unlike the previous wave, sponsors are mostly Chinese – with the exception of Sequoia Capital – and they are being financed by Chinese lenders.

That's unsurprising; many foreign sponsors find A-share exits unattractive due to a limit on price-to-earnings ratios as well as regulatory uncertainty, such as IPO suspensions.

VIE consolidation

Greater regulatory certainty around variable interest entities (VIEs) has been one reason companies are looking to move back onshore.

VIEs are typically used to circumvent Chinese restrictions on foreign investment in ecommerce and other sensitive sectors. Under a VIE, the offshore holdco has a wholly-owned subsidiary in China that, instead of operating a restricted business or owning equity interests in a company that operates in a restricted space, has contractual relationships with that company.

In the past few years it's been unclear how the Chinese government has viewed these structures.

However its draft Foreign Investment Law, released in January, clarified its stance. It said that VIEs controlled by foreign entities will be considered foreign-invested entities – and definitions of control can be nebulous.

There is a solution, however. A pilot programme in the Shanghai FTZ allows 100% foreign ownership of ecommerce businesses, said Tang. A recent circular from the Ministry of Industry and Information Technology on June 19 further expanded such permission across the country.

"Having said that, that's a general guideline from the government, and you may need to wait for some time to test how this initiative will be implemented," she said.

Tang believes this is a signal that the Chinese government is more open to foreign investors holding, controlling or having 100% equity interest in TMT companies. "We hope that there is a more level playing field for both domestic and foreign investors," she added.

What's next

None of the companies that have proposed take-privates have announced changes to their plans following the A-share crash and subsequent government support.

Even with the lengthy timeline for take-private deals, however, the recent market crash could jeopardise their plans.

"The practical reality is that a lot of these take-private deals may be in trouble," said Paul Hastings' Freeman. "Some of the better quality ones may get through, but it will be hard for all of them to get done."

But this flurry of deals could encourage other participants to consider take-privates. Freeman noted that this wave of take-privates has largely been financed onshore with very little foreign PE sponsor money.

"In any event, this wave has interested PE sponsors in this space again, and I wouldn't be surprised if we see more of these deals – even past the current situation with China's A-share market – based on different fundamentals," he added.


By Ashley Lee, IFLR