CP Group and Itochu buy $10.4 billion Citic Ltd stake

Deal to buy a 20% stake in the Chinese state-owned enterprise is the country's largest inbound M&A deal on record.

Charoen Pokphand group, headed by Thailand's richest man Dhanin Chearavanont, and Japanese trading firm Itochu have agreed to buy a 20% stake in Citic Ltd for about HK$80 billion ($10.4 billion), in a further sign that China's state-owned giants are opening the door to private capital.

The investment would be one of the largest into a Chinese SOE and comes at a time when valuations are undemanding, according to some analysts.

Both Itochu and CP Group already have deep relations with Citic entities and ties to the mainland. In 2011, Itochu invested about $100 million in a Hong Kong asset management arm of Citic Group.

Meanwhile, Chearavanont has close ties to the mainland and, since China opened up the country in 1979, CP Group was the first foreign entity to invest in China and was involved in agricultural reform.

Both Itochu and CP Group last year formed an alliance to cooperate in animal feed, livestock and marine-related areas.

Prior to the deal being announced, Chia Tai Bright Investment (CT Bright), which is jointly held by the two companies, already held a 1% stake in Citic Ltd, which was formerly known as Citic Pacific. 

However, the latest deal is a far bigger commitment and will allow a broader range of cooperation. According to a statement by Itochu, potential areas of synergy include consumer-related sectors, resources and the creation of new business, including water & environmental and agricultural-related business.

Both Itochu and CP Group will have some presence on the board and will have the right to nominate one non‐executive director and one independent non‐executive director to the board of Citic Ltd.

“As the first international company to invest in China following the re-opening of the economy, since 1979, CP Group has built a significant presence in a range of business areas and we are excited by this opportunity to invest in the country’s largest diversified conglomerate,” Chearavanont, chairman of CP Group, said in a statement.

Grappling with free float

Given the fact that Citic Ltd is grappling to meet its free float requirements, the deal is structured in two stages. Currently, government owned entity Citic Group owns about 77.9% of Citic Ltd and the remaining 22.1% of Citic Ltd is held by public shareholders. However, the Hong Kong Stock Exchange requires a minimum free float of 25%. According to a source familiar with the matter, Citic Ltd is not allowed to lower its free float any further from prevailing levels.

Itochu and CP Group will be investing jointly through CT Bright, which will buy a 10% stake in Citic Ltd from Citic Group, for about $4.54 billion. The acquisition is targeted to be completed in April.

In several months time, Citic Ltd will issue CT Bright convertible preferred shares that are convertible to 13.4% of the current voting rights for $5.9 billion in cash. 

At present, the preferred shares have no voting rights. However, according to an Itochu presentation slide, the preferred shares will be converted to ordinary shares within three months of acquisition, subject to compliance with the public float requirement of the Hong Kong Stock Exchange. The acquisition is targeted to be completed in October this year.

The preferred shares and Citic Ltd shares will each be sold at HK$13.8 per share, a 3% premium to the closing price of HK$13.32 on January 19. On January 20, Citic Ltd shares rose to close HK$13.52.  

Undemanding valuations

Citic Ltd last year raised HK$53.4 billion ($6.9 billion) by selling shares to 27 investors at HK$13.48 per share to fund the acquisition of assets injected by its parent Citic Group.

Since then, Citic Ltd's shares have been underperforming, often trading below that price at times. For the existing Citic Ltd shareholders, the fact that Itochu and CP Group are coming in at a higher price is a positive, said one of the investors.

Yet even so, analysts suggest Citic Ltd's current valuations are inexpensive. In a research note, Jefferies said that the valuation on Citic Ltd’s stock is undemanding as it trades at 5.9 times estimated 2015 earnings and 0.7 times price to book. The note added that the deal is positive for Itochu in the long term as it helps to boost return on equity to 15%-plus in the mid-term and the broker expects the deal to be earnings accretive.

Itochu is expected to tap Japanese lenders, which can provide cheap funding. "Borrowing money is just so cheap," said one analyst. "The 10-year JGBs are yielding only 0.2% and Japanese lenders are very keen to lend to these big corporates," he added.

Citic Ltd's independent shareholders will vote on the deal at an EGM expected to be held in March.
Nomura was the main adviser to Itochu. Citic Securities advised Citic Ltd. Citic Ltd has appointed Somerley as the independent financial adviser to the Independent Board Committee and the independent shareholders

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