US buyout fund Carlyle Group and some of China's top private equity funds are targeting the biggest ever delisting of a New York-listed Chinese company, attempting to privatize a firm directly targeted by shortseller Muddy Waters.
The offer is the latest, and biggest by some distance, in a string of attempted management-led buyouts by US -listed Chinese companies, whose reputation among US investors has suffered after a series of alleged accounting scandals.
Carlyle, the world's biggest fund by assets, FountainVest Partners, CITIC Capital Partners, CDH and China Everbright are backing a proposed $3.5 billion delisting of display-advertising firm Focus Media Holding Ltd ), working with the company's chief executive.
Private equity funds have been picking over hundreds of China firms listed in the United States, looking for viable takeover targets, but until now the deals have all been below $1 billion, largely because of difficulties getting financial backing.
"Where these firms have often struggled with the delisting process is in getting financing to back them," said Paul Boltz, partner at law firm Ropes & Gray, which has worked on a number of take-private transactions.
Funding for buyouts of Chinese companies is done through an offshore holding company, but many banks cannot lend on such deals due to the risk of non-payment. Banks have to get comfortable with the risk that the firm will make enough revenue to pay its debt, that it will pass on the funds to the holding company, and that Chinese regulators will sign off on the transaction.
Citigroup, Credit Suisse and DBS Bank are backing the Focus Media deal, and have asserted they are highly confident of underwriting a financing.
Ropes & Gray estimate that 11 China firms have so far been delisted from the United States, while a further 17 including Focus Media are now in the process of attempting to delist. Four companies attempted to delist but then cancelled, including Puda Coal.
Focus Media shares, which peaked above $66 in 2007, jumped 8 per cent to $25.26 on the bid, but were still short of the offer price of $27 per American depositary share.
Short selling
Shanghai-based Focus Media -- which operates advertising screens in offices, elevators and supermarkets across China -- has faced persistent allegations from short-seller Muddy Waters that it overstated its assets and overpaid for acquisitions.
Its stock fell 40 per cent in a day last November after a Muddy Waters report, which the company said did not take into account its digital screens and LCD picture frame devices.
In January, the firm denied further allegations about irregularities in the purchase of a ginseng plantation.
"Focus Media is under a lot of valuation pressure because of controversies surrounding the company," said T.H. Capital Research analyst Tian Hou, adding that a successful deal would help other Chinese companies regain credibility among US investors.
The Focus Media deal triggered a 7 per cent jump in shares of New Oriental Education & Technology Group Inc (EDU.N), which Muddy Waters has accused of lying about its network and cash balances.
Muddy Waters founder Carson Block welcomed the offer, telling Reuters: "The markets are far better off if a few deep-pocketed investors own Focus Media instead of mutual funds and other public shareholders."
Buy-out increasing
The increased scrutiny on US -listed Chinese firms has depressed their share prices and encouraged management buy-outs to take advantage of big discounts to peers on the Hong Kong and Chinese stock markets.
The deals, known in banking circles as "take China privates" have so far been relatively small, but history shows that for private equity there is high upside potential.
Morgan Stanley Private Equity's delisting of Sihuan Pharmaceutical Holdings Group Ltd (0460.HK) is regularly cited as an example of returns that can be made with the right target.
MSPE took Sihuan private in Singapore in 2009, identifying a company that required no additional work before relisting in Hong Kong in October 2010. The stock jumped 28 per cent on its IPO, with top-end pricing valuing the company at 26.7 times 2011 earnings.
In the past year, Harbin Electric, Chemspec International and China Fire & Security have all been delisted from the United States, by Abax Global Capital, Primavera Capital and Bain Capital respectively.
Fushi Copperweld Inc (FSIN.O), China TransInfo Technology Corp (CTFO.O) and Winner Medical Group Inc are among many that have accepted take-private offers from their managements but are yet to complete the privatization process.
Shares of Focus Media trade at a multiple of 8.3 times their forward earnings, a deep discount to its five-year historical average and the industry average, according to Thomson Reuters StarMine.
"We think the (Focus Media) stock has been undervalued trading at high single-digit PE when the earnings growth is expected to be above 20-25 per cent," Macquarie Securities analyst Jiong Shao told Reuters.
"Focus Media has a great business, generates tons of cash, pays dividend and buys back its shares."
The company's board has formed a committee of independent directors to consider the offer. Chief executive Jason Nanchun Jiang held about 18 per cent of the outstanding shares as of December 31, according to the company's annual report. He bought $11 million of the company's ADSs in November.
