The transaction will be done in the form of a voluntary general offer with Gome offering to pay a total of $5.27 billion ($677 million) primarily through a share swap but with a small cash component on top. If completed, it will mark the first true takeover of size involving two Hong Kong-listed mainland companies, not counting clean-up exercises within the same group.
The fact that the takeover û or merger as the two parties prefer to call it û comes a mere nine months after China ParadiseÆs IPO and at the slightly lower price than that fetched in the initial share sale makes the deal even more intriguing.
The intention is to de-list China Paradise, but to continue to operate under two separate names to capitalise on the strengths of both the Gome and China Paradise brands in the domestic market.
Gome, which is already the market leader in terms of number of retail outlets, is offering 0.3247 of its own shares for each one share in China Paradise as well as an additional HK$0.1736 per share in cash to take over the number three player. Based on the latest traded share prices, the offer values each China Paradise share at HK$2.2354, or at a 9% premium to its most recent close of HK$2.05.
Looking at it the other way around, Gome will pay one of its own shares (plus the cash portion) for 3.08 China Paradise shares. According to sources, the basic deal structure was in place by the time GomeÆs shares were suspended from Hong Kong trading last Tuesday, and were not changed in the interim period despite widespread media speculation about Gome having to sweeten the deal after China Paradise rejected its first offer.
ôThis is not a hostile takeover. The parties have been in negotiations that resulted in this offer,ö says one source familiar with the process.
Gome, which is controlled by mainland tycoon, Wong Kwong Yu, is being advised by Goldman Sachs, while China Paradise is taking advice from Cazenove.
China ParadiseÆs share price has tumbled 52% from its record high of HK$4.30 in April and last traded at HK$2.05 before it was suspended last Monday (July 17) û 8.9% below the IPO price. At one point in late June it was even trading as low as HK$1.84. This, and a lack of confidence in the managementÆs ability to execute its business plans (triggered by disappointing first quarter earnings) should make most shareholders happy to get an exit route, analysts argue.
Investors who bought into the $153 million placement of secondary China Paradise shares in April at HK$3.225 apiece û a level not revisited since - may be especially keen to swap their shares for less tarnished paper in a stronger group that will be better able to fend off the fierce price competition in the industry.
ôHad it been a cash bid only, it would have meant realising the losses and walking away, but the idea here is that they will be able to participate in what people hope will be a tremendous amount of upside,ö one observer says. ôBy combining the number one and number three players you will likely change the industry dynamic quite a bit and that should make them (China Paradise shareholders) better off than the situation they are in now.ö
Indeed, a joint statement issued by the two parties last night seemed to suggest that China ParadiseÆs earnings have continued to deteriorate since the company issued a profit warning together with its first quarter earnings report.
Having initially said that its first half earnings may be lower than for the same period last year the company yesterday noted that in view of the severe price competition and an unsatisfactory performance at new stores in the northern and southern regions of China, these statements are ôout of date and no longer representative of the financial condition of China Paradise.ö
That comment can only be interpreted to mean more negative news is in store when the first half earnings come out on August 15.
A merger with Gome, on the other hand, would result in a combined entity that has more purchasing power and which will be able to eliminate overlapping costs, representatives for the two companies said at a press conference in Beijing yesterday that was broadcast via video link to Hong Kong, Shanghai, Tianjin and Shenzhen.
The new group, which will be renamed to reflect the combined businesses, will, with its larger balance sheet, also be in a better position to pursue other opportunities in a consolidating market, they argued.
The need for both companies to strengthen their position in the market was seen to become more urgent after US-based Best Buy in May acquired a controlling stake in ChinaÆs fourth largest consumer electronics retailer, Jiangsu Five Star Appliance. However, according to sources, Gome and China Paradise have been in serious discussions about a merger for about five months.
China ParadiseÆs largest shareholders, including Chairman and co-founder Chen Xiao and Morgan Stanley, which holds 9.52% through a private equity arm, have already agreed to accept the offer, which indicate that they at least think it is a good one in light of the companyÆs deteriorating profitability and outlook.
Their irrevocable undertakings, which account for 31.17% of the total share capital, together with the intention by a group of shareholders known as ôRetail Managementö to accept the offer on behalf of another 30% stake that is under lockup until October 13, means Gome is already two thirds on its way to achieve the 90% acceptance it needs to make the offer compulsory.
The combination of GomeÆs 296 retail stores with China ParadiseÆs 205 will create a market leader with 501 stores. And if the home appliance stores currently owned by the Gome chairman were to be injected into the group, as he has promised they will be by 2011 at the latest, the new group will have a total of 697 stores. That would be more than three times as many as Shanghai-listed Suning, which is the second largest player.
What is remarkable though, is the almost perfect fit between the Gome and China Paradise retail networks. For Gome, the key addition will be the 52 stores that China Paradise operates in Shanghai, which will propel it from todayÆs zero presence to the market leader virtually overnight.
But the absence of an overlap is noticeable elsewhere as well with Gome having 39 stores in Beijing to China ParadiseÆs five and the latter having no presence in provinces like Chongqing, Hebei, Hubei, Liaoning, Shandong and Yunnan where Gome has a total of 83 outlets. Similarly, China Paradise is represented in Henan and Zhejiang (43 stores) while Gome is not.
ôThe geographical match between the two companies is startling,ö says one observer.
However, even with the new entityÆs clear lead in terms of retail outlets, the consumer electronics market in China remains highly fragmented and the combind market share will be less convincing. One source estimates that Gome/China Paradise will have about 10% of the market compared with GomeÆs 6-7% share today.
Consequently, the need for more consolidation is likely to remain a factor with the number two player left in limbo.
An analyst at Kim Eng Securities noted in a recent report that it is very likely that Gome will eventually also acquire Beijing Dazhong since China Paradise in April paid Rmb150 million ($18.7 million) for the rights to buy this company û the largest home appliance chain in Beijing û if the owner decides to sell within a year.
If it does, ôSuning will be left the weakest link in the market, and vulnerable to any other possible M&A,ö the report said.
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