Buyout firms continue to gamble on take-private deals

Many Chinese companies listed in the US are finding life difficult these days as accusations of fraud and dodgy accounting continue to pile up. But, as one group of investors shuns these reverse-merger companies, some buyout firms are still convinced they can make money from taking them private and realising higher valuations by re-listing back in Asia.

US private equity firm Abax Global Capital likes the idea so much it has just completed its second take-private deal, having agreed a $364 million buyout of Nasdaq-listed Fushi Copperweld in partnership with the company’s chairman and co-chief executive, Li Fu.

Their offer of $9.50 a share was 21% higher than Fushi’s closing price in New York last Thursday, the day before the offer. Fushi has been courting suitors since at least 2010 and is said to have held an auction last November that failed to uncover an acceptable bid, including Abax’s offer of $9.25.

Financing, ultimately, is one of the biggest issues motivating Chinese companies to consider leaving the US. “The problem is that the assets are in China, the collateral is in China,” said a source who has worked on a number of take-private deals. “And investors in the US are cautious about Chinese reverse-merger companies.”

In the case of Fushi, the buyout is being financed by China Development Bank and will go forward with an undisclosed mix of debt and equity. It is expected to be approved by shareholders in the fourth quarter.

Abax and Fu have not said what their plan is after that, but the clear aim of such deals is to re-list at a premium in China or Hong Kong. Abax’s first take-private deal involved the buyout of Nasdaq-listed Harbin Electric and there have been 15 other buyouts since the start of 2010, according to Dealogic, including private equity-led deals by Bain Capital for China Fire & Security and PAG for Funtalk China, and the management-led privatisation of Shanda Interactive.

However, the path to re-listing may not be easy. Almost 700 companies are waiting to launch initial public offerings in China and, while regulators said in June that they would greatly reduce the administrative procedure for IPO approvals, it is unclear how favourably Chinese officials will look at such companies. They may conclude that many of these businesses have already demonstrated poor judgment in choosing to list in the US in the first place, and could subject them to added scrutiny as a result.

“A lot of the smaller companies should never have listed in the US,” said the source. “They never got the traction in terms of liquidity or valuation, but they got sucked into this get-rich-quick idea.”

Many of the reverse-merger companies are too small to qualify to list in Hong Kong and, even if private equity investment can help them to eventually clear the bar, investors will need some convincing to pay the high valuations needed to provide an attractive return.

Some private equity firms may have secured guaranteed payments in the event that IPOs fall through, according to another source, but the terms of such deals are unlikely to be attractive enough to offset the risks, which include the headache of class-action law suits from investors in the US.

However, Abax and the other firms involved in the take-private trend clearly consider the potential upside to be sufficient to justify such risks. Likewise, the investment banks and other firms that advise on these transactions will also be keen to realise fees from an IPO down the line.

The financial advisers in the Fushi deal are Bank of America Merrill Lynch for the special committee and Deutsche Bank for Fu and Abax. The legal advisers are Gibson, Dunn & Crutcher for the special committee; Loeb & Loeb for Fushi; Skadden, Arps, Slate, Meagher & Flom for Fu; and Weil, Gotshal & Manges for Abax.

With a valuation at close to $400 million, Fushi is clearly not a small business and may find it easier than some of the smaller take-private candidates to re-list in China or Hong Kong — and the backing of BoA Merrill and Deutsche reinforces that idea.

Fushi has been listed in the US since 2007, when it paid $22.5 million for Copperweld Bimetallics.