'Delist-relist' strategy bears risks for privatized firms

By now, the strategy has become familiar to those who follow US stock markets: Controlling shareholders and executives of Chinese companies whose stock trades in the United States respond to depressed share prices by making deals to take the companies private.

More often than not, their financial backing comes from global buyout firms such as Blackstone Group or Carlyle Group, or from Chinese firms like Citic Capital Partners.

The acquisitions are priced at large premiums to share prices that have plunged because of the perception among US investors - accurate or not - that bad accounting is commonplace among companies based in China.

After the acquiring consortium buys out the American shareholders, the plan usually is to delist the company's US shares and then cash out by relisting in China, where the shares theoretically should trade higher, based on the performance of their peers on the Hong Kong and Shanghai bourses.

The latest US-listed Chinese firm to be involved in a going-private deal with private equity is information-technology outsourcing firm Pactera Technology International Ltd, which last week received a $662.3 million offer from a consortium led by New York-based Blackstone.

But Peter Fuhrman, chairman of China First Capital, a Shenzhen-based investment firm, questions the wisdom of using "risky" private-equity buyouts as an exit strategy for Chinese firms. In an August 2011 opinion essay in the Wall Street Journal, he noted that hundreds of Chinese companies had gained listings in the US through reverse takeovers, "injecting all of their assets into a dormant shell company" with shares traded on a US exchange.

"Only then do the Chinese firms discover the enormous compliance costs associated with being listed in America, not to mention the low valuations for US-traded shares relative to what a Chinese company could pull from equity markets back in China," Fuhrman wrote.

Taking a company private, he added, is normally a complex business, but the "distance, differences in accounting rules, and unusual corporate structures" involved in privatizing a Chinese company are "likely to lead to bigger disputes over what a company is actually worth".

And "it is far from certain that these Chinese companies, once taken private, will be able to relist in China", the investment manager wrote.

He noted that any proposed initial offering in China must be approved by the China Securities Regulatory Commission.

"There is a low chance of success," according to Fuhrman. "No one knows the exact numbers, but from my own conversations with Chinese regulators, it seems likely that only 10 percent to 15 percent of the more than 150 companies per month that applied to list last year [2010] gained listings.

"Companies whose US listings failed will almost certainly suffer a serious stigma in the [regulator's] eyes," Fuhrman warned, adding that private-equity companies "could end up owning firms that are delisted in the US and unlistable in China".

If a deal were to go wrong, he added, the private-equity investor would be vulnerable to litigation by its limited partners for breach of fiduciary duty.

"Such a lawsuit, or even the credible threat of one, would likely put the PE firm out of business by making it impossible for the firm to raise money," Fuhrman wrote.

Why, then, would private-equity firms consider these deals? Fuhrman's explanation: "Because they appear easy. The target company usually is already trading on the US stock market, and so has a lot of disclosure materials available. Investing in private Chinese companies, by contrast, is almost always a long, arduous and costly slog requiring extensive due diligence."

The only people certain to do well out of these "delist-relist" deals, according to Fuhrman, "are US investors who sell out at a small premium in the 'take-private' part of the deal".

Jim Fink, an analyst with the website Investing Daily, told China Daily that the large share premiums in deals such as Blackstone's proposed Pactera takeover - more than 42 percent above the market price - could attract other US-listed Chinese firms to seek going-private offers.

"Approximately 20 of the 230 US-listed Chinese companies are already in some stage of the privatization process," Fink said.

He was more optimistic than Fuhrman about a newly privatized firm's chances of being relisted on an exchange. "Good companies with solid financials will always be able to relist because there will be public demand," Fink said.

Long-term implications of this wave of going-private deals may not be clear, but the speed at which global financial markets move could mean that answers will arrive sooner rather than later.

Contact the writer at michaelbarris@chinadailyusa.com